SOLE PROPRIETORS, INVESTORS
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RENTAL INCOME

General Rule

In general, gross income from real property located in the United States that is owned by a nonresident alien is taxed at a 30% (or lower treaty) rate if it is not effectively connected with a U.S. trade or business.

Special Election

If you have income from rent of real property located in the United States that you own or have an interest in and hold for the production of income, you can choose to treat all income from that property as income effectively connected with a trade or business in the United States. The choice applies to all income from real property located in the United States and held for the production of income and to all income from any interest in such property. You can make this choice only for real property income that is not otherwise effectively connected with your U.S. trade or business. If you make the choice, you can claim deductions attributable to the real property income and only your net income from real property is taxed. This choice does not treat a nonresident alien, who is not otherwise engaged in a U.S. trade or business, as being engaged in a trade or business in the United States during the year.

Example. You are a nonresident alien and are not engaged in a U.S. trade or business. You own a single-family house in the United States that you rent out. Your rental income for the year is $10,000. This is your only U.S. source income. The rental income is subject to a tax at a 30% (or lower treaty) rate. You received a Form 1042-S showing that your tenants properly withheld this tax from the rental income. You do not have to file a U.S. tax return (Form 1040NR) because your U.S. tax liability is satisfied by the withholding of tax. If you make the choice discussed earlier, you can offset the $10,000 income by certain rental expenses. Any resulting net income is taxed at graduated rates. If you make this choice, report the rental income and expenses on Schedule E (Form 1040) and attach the schedule to Form 1040NR. For the first year you make the choice, also attach the statement discussed next.

Making the election.

Make the initial election by attaching a statement to your return, or amended return, for the year of the choice. Include the following in your statement.

  1. That you are making the election.

  2. Whether the choice is under Internal Revenue Code section 871(d) or a tax treaty.

  3. A complete list of all your real property, or any interest in real property, located in the United States. Give the legal identification of U.S. timber, coal, or iron ore in which you have an interest.

  4. The extent of your ownership in the property.

  5. The location of the property.

  6. A description of any major improvements to the property.

  7. The dates you owned the property.

  8. Your income from the property.

  9. Details of any previous choices and revocations of the real property income choice.

This election stays in effect for all later tax years unless you revoke it.

For more details see Treasury Regulation 1.871-10(d)(1).

State Issues

Generally, a state authority also requires tax payment or/and withholding on payments made to nonresidents for income received from state sources. Please note that state tax rules are complicated and every state has its own set of rules. When state tax rules are not followed, there are penalties and interest imposed.