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US Tax Rules On NZ Rental Properties Are Changing

For many years, owning a rental property in New Zealand was fairly straightforward from a US tax perspective.


However, this is unfortunately no longer the case, and we’ll give a brief explainer here of what has changed.


Since 2018, the IRS have made various different changes to the reporting required for foreign disregarded entities. In short, this means any business activity which could constitute a separate entity under US tax law.


How we used to report a rental property


Previously, the US Tax implications of owning a New Zealand rental property were quite basic. As part of the annual US tax return, Form 1040, an additional schedule would need to be added, Schedule E.


On Schedule E, rental income and expenses would be reported, and US tax calculated on the rental income.


Later in the tax return, Form 1116 could be used to claim a foreign tax credit for NZ tax paid. This in almost all cases would offset the US tax entirely on the rental income.


To explain further, the NZ US tax arrangement for a rental property is determined through the NZ US double tax agreement, the DTA. Under the DTA, the country where the property is physically located would usually have the first right to tax.


This term “first right to tax” means the country can tax the rental income, and don’t need to allow a credit for tax paid to the other country.


With NZ having first right to tax a rental property, then the foreign tax credits would usually be sufficient to offset the US tax bill calculated from Schedule E.


This was about the crux of it, and it meant most US citizen owners of NZ rental property, usually paid no tax to the US on annual rental income.


How do I report my NZ rental income on my US tax return now?


So, the first part above on Schedule E, still exists without any changes.


However, the main change comes through the reporting required for foreign disregarded entities, as mentioned in the introduction.


As part of the changes made by the IRS to this reporting, owning a rental property has (some say inadvertently) been caught up in new reporting requirements.


Specifically, rental property income must now also be reported on Form 8858 - Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs).


So you might be thinking here, that this only affects people who own a rental property through a company that they own. Unfortunately, this is not the case.


As part of the sweeping changes made to the requirements of who must file Form 8858, taxpayers must now report any business income which qualifies as a foreign branch or foreign qualified business unit.


The specific definition and extract from the instructions is below:


An FB is defined in Regulations section 1.367(a)-6T(g). For purposes of filing a Form 8858, an FB also includes a qualified business unit (QBU) (as defined in Regulations section 1.989(a)-1(b)(2)(ii)) that is foreign.


The above is part of the “who must file” section of Form 8858 instructions.


So, we know from this that any business activity which qualifies as a foreign branch or foreign qualified business unit is required to file form 8858.


So, now we move onto the definition under the tax code:


§ 1.989(a)-1 Definition of a qualified business unit


(b) Definition of a qualified business unit—(1) In general. A QBU is any separate and clearly identified unit of a trade or business of a taxpayer provided that separate books and records are maintained.

(ii) Activities. Activities of a corporation, partnership, trust, estate, or individual qualify as a QBU if—

(A) The activities constitute a trade or business; and

(B) A separate set of books and records is maintained with respect to the activities.


As you can see above, a rental property fits into this definition because:


- A rental property is by its very nature, a business activity (ie seeking income from rent)

- Separate records are kept, detailing rent received and expenses, to define profit


So what does this actually mean for me if I own a rental property?


Fortunately, the most important question, is that this will not result in any additional tax.

Form 8858 is an informational tax return, and no tax is calculated using this form. It is simply an information reporting requirement by the IRS.


So, your tax liability on the rental property is unaffected.


However, for any US citizen owner of an NZ rental property, Form 8858 will now be required with your tax return going forward. This can be quite a complex form, and you should be prepared that your tax professional may need to spend some extra time on your tax return in future.


Does the IRS really want me to file Form 8858?


The answer to this can of course only be answered by the IRS.


However, amongst the NZ US tax industry, along with the wider US international tax field, it is generally agreed that the IRS did not intend to require this reporting for rental properties. However, the law has been written in such a way that the requirement has now been created, and can only be changed through a modification to the law. Time will tell if this actually happens, or whether there is any desire on the IRS side to go through the administrative burden of adjusting the law.


Summary


If you own a rental property in New Zealand, fortunately you will not be subject to extra tax as a result of these forms.


However, your tax return will become slightly larger each year, and you do need be prepared for some extra paperwork obligations.


If you’d like to discuss further or obtain any other US tax advice, reach out to us today – info@usatax.nz– 09-242-3445

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