Section 987 – Self-Employment and Rental Business – New Reporting

Whilst Christmas seemed not that long ago, here we are already in February, and some of the tax code changes made in 2025 are now beginning to take effect.

In our article today, we’ll discuss the new final regulations under Section 987 of the US tax code. This code section has been under development by the IRS for more than 30 years, partially due to its complexity but also in attempt to find fairness in its implementation. The regulations became final in December 2024, and as a result we will begin to see changes for the new US tax year, 2025.

What is a QBU and who does Section 987 Affect?

If you’re a US person living overseas with a rental property or self-employment income, there’s a good chance the IRS now considers you to have a Qualified Business Unit. We’d discussed this previously in our article here. This new US tax code section could well be considered an extension of the filing obligations placed on owners of foreign unincorporated businesses.

As a brief reminder, a QBU can be any foreign (ie non-US) business activity, regardless of whether a New Zealand company is formed.

A QBU doesn’t require a company. It doesn’t require registration. If you earn income overseas and keep your books in a foreign currency, that can be enough. Foreign rentals and sole traders usually fall into this category, due to the requirement to maintain records of income and expenses (thus meeting the books/records requirement under the IRS definition of a QBU).

What does Section 987 Change?

What Section 987 is really about is currency. The IRS is seeking to ensure that FX fluctuations that occur and can create income are captured. This is relevant for a QBU if its trading income (ie NZD) is different to the owner’s tax currency for federal tax purposes (USD). We’ve covered other forms of FX gain reporting previously, however unrelated to QBUs.

For a long time, most people just converted income each year and moved on. The regulations now require us to calculate income or loss of exchange rate movements separately from the underlying profit.

That matters because currency moves even when nothing else does.

What does Sec. 987 mean in practical terms?

If you own a rental property overseas, the value of that property in USD terms can rise or fall purely because the exchange rate moves. When the rental activity ends or the property is sold, Section 987 can force a recognition of that currency movement. That gain or loss sits outside the normal rental or capital gain calculation and can show up as taxable income even though no extra cash ever appeared.

Self-employed clients run into the same issue. If your business operates in a foreign currency and you later shut it down, withdraw funds, or materially change how it operates, the accumulated FX difference doesn’t just disappear. Section 987 is how the IRS pulls that number back into the tax return.

Section 987 requires your US tax accountant to calculate the spot rate conversion of every remittance (ie income) and contribution to and from an NZ QBU, which is used to determine the total FX gain/loss realised for the year. As you might expect, this has the potential to add many hours to the information gathering and return preparation process.

The problem isn’t that this always creates tax. Often the numbers are small. Sometimes it creates a loss. The problem is that ignoring it means the return is technically wrong, and that tends to matter most at exactly the worst time — when something is sold, restructured, or reviewed.

Are there minimum reporting thresholds for Section 987?

Fortunately yes, but limited exceptions exist. Under Section 987 we are required to calculate “pre-transition gain/loss”, which is essentially a calculation going back to 1996, to determine foreign currency gains or losses within a QBU. Fortunately the de-minimis exemption allows QBUs with a value under $25m (broadly speaking), to avoid calculating the pre-transition gain or loss. Whilst this does little to help going forward, it certainly helps to reduce the complexity of 2025.

Summary

The practical takeaway is simple. If you have an overseas rental or you’re self-employed outside the US, Section 987 is now likely to become part of your annual filing requirements.

If you’d like to discuss further, reach out to us today. The US Tax Team New Zealand offer US tax planning and US tax specialist advice – info@usatax.nz