Tax Ramifications If You Own Property Outside The U.S.
- If you own or invest in Mexico, you may have a Foreign Trust
- If you have a Foreign Trust, the I.R.S. wants to Tax You
Millions of Americans own or invest in vacation property, rental property, or other real estate outside the United States creating foreign income and other U.S. foreign tax reporting obligations and tax consequences.
I. How can owning or investing in property in Mexico create a foreign income and tax filing and payment obligations?
Mexico restricts and limits foreign investment in coastal real estate by requiring that the rental, vacation, or investment property be held in a Fideicomiso or a Mexican Corporation (generally used for non-residential investment).
A. What is a Fideicomiso?
The Internal Revenue Service takes the position that a Fideicomiso is a Foreign Trust. U.S. citizens acquire coastal Mexican real estate through a Mexican Bank Trust (called a Fideicomiso) which names the buyer of the property as a beneficiary of the trust. This Fideicomiso then administers the property according to the instructions of the buyer/beneficiary, who retains full ownership rights. These foreign trusts must then be reported on the beneficiaries’ U.S. tax return(s).
B. How does a Fideicomiso affect U.S. taxes?
Basically owning or investing in rental, vacation, or commercial property in Mexico will affect individual tax filing requirements and how individual income taxes are calculated. See Below. Further the trust itself has certain tax and accounting requirements that are not addressed in this Alert.
C. Filing/Reporting Requirements
In addition to individual income tax returns, involvement in a foreign trust may trigger the requirement to file certain reports and statements with the Internal Revenue Service and/or Department of the Treasury. The most common types of forms that a foreign trust will require are:
* Form 3520- Report of Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts;
* Form 3520-A- Annual Information Return of Foreign Trust with a U.S. Owner;
* Form 1040, Schedule B, Part III, Foreign Accounts and Trusts;
* Form 8938, Report of interest in a specified foreign financial assets;
* Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts; and,
* Form 1040 NR.
Caveat: you should consult with a tax attorney as to your filing requirements and obligations. The above list is only a partial list of what may be required of you.
Even to tax lawyers these reports and official tax documents can be complicated and have long lasting tax implications. For instance, Form 3520 is six pages long but requires eleven pages of instructions. Further, all documents are signed under penalty of perjury, just like your tax return. This means that you are required to provide a truthful and complete disclosure. From a tax lawyer’s perspective, it means that any misstatements or incompleteness can be used against you.
D. Income Tax Implications
i. Tax Aspects of Foreign Beneficiary Trusts such as a Fideicomiso
Generally, a U.S. beneficiary of a foreign trust is required by law to report their share of foreign trust income and distributions. Moreover, because of various tax credits and offsets that may be applicable, we recommend that a qualified tax attorney or Certified Public Accountant advise you in preparation of your returns.
ii. Taxing your own use of your own real property
The HIRE Act, effective 2012, treats uncompensated use of property held in foreign trusts as distributions to the beneficiaries and thus subject to income tax. This means that if you have an interest in an offshore trust and you are the beneficiary, utilizing the property without paying the rental fees or the fair value of the use of the home, taxable income to you on your form 1040.
E. Civil tax penalties for not filing tax returns or non-compliance of U.S. Tax Code
There are a plethora of civil tax penalties that may be assessed for failing to file returns associated with the foreign trust or filing incomplete statements. In the spirit of brevity, we not address all of the potential penalties here at this time. However, some examples of the monetary implications for not filing the required forms/statements/disclosures are below:
5% of the gross value of the trust assets & $10,000 per 30 days (prorated)
If non-willful, up to $10,000 per violation or the greater of $100,000 or 50% of the account value
For failing to file a complete and correct form, the penalty is $10,000 with an additional incrementing penalty each 30 days the form is late.
These are just examples of some of the specific penalties that can and will be imposed. Traditional accuracy related penalties, civil fraud penalties and negligence penalties may also apply thus making it very expensive for beneficiaries of foreign trust who (intentionally or non-intentionally) fail to comply with the U.S. Tax Code and Bank Secrecy Act.
F. Tax Fraud and Criminal Tax Investigation for persons involved with foreign trusts
To help prevent the use of foreign trusts and other offshore entities for tax avoidance or deferral, Congress has enacted several specific provisions in the Internal Revenue Code, most recently the HIRE Act and Bank Secrecy Act (BSA), and has made top priority that the Tax Division of the United States Department of Justice’s combat non-compliance with tax filing requirements and/or tax evasion.
The top priority status in addition to increased duties placed on individuals to disclose income and assets to the IRS via tax form filing requirements, taxation of foreign trusts, and through various data collecting initiatives, has made it easier and faster for the Internal Revenue Service and Department of Justice to collect and match individuals to data and assess whether a taxpayer is in compliance with their filing obligations.
II. What to do?
A. If you have been reporting the trust and filing all required forms
We recommend that you contact a qualified tax attorney to review your tax obligations and filings to determine if there are legal ways to minimize or avoid tax liability. For instance, sometimes a simple adjustment to how or where property is held, may make a big difference in the taxes you pay to the U.S. government.
B. If you have NOT filed required tax forms
We recommend that you consult with a tax attorney immediately to assess the civil and criminal implications of your case.
DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
(About the author: Stephen M. Moskowitz is the Senior Partner of Moskowitz LLP, located in San Francisco. His practice of over 30 years covers the entire spectrum of tax law for individuals and businesses.)