The IRS has determined that a number of individual U.S tax returns filed by a NRA (“non-resident alien) have not attached to their tax return, the requirement per S871(d) of the IRC Code, a statement indictive of the election to treat the rental income as income effectively connected with a trade or business (“ECI”). The IRS has also determined that a number of non-residents have not reported rental income from U.S. property rentals. This could also be for those who have trust or partnership interests who automatically receive a K-1 or even those who receive the gross rent directly from the leasee where is no withholding agent or management company.
This forgoing election is outlined in the regulations and must be attached to the tax return for the first year in which the election is to be in place. Providing an IRS Form W8-ECI waiver to the payor of the rental income is only a mechanism to waive the 30% withholding on gross rent with the condition that the non-resident individual will file a tax return. The W8-ECI waiver is good for 3 calendar years and I doubt that management companies are following up or even know if the taxpayer is filing a return.
The election allows the filing of a tax return (1040NR for individual filings) to report on Schedule E gross rent less allowable deductions, hence taxing at income at graduated tax rates as opposed to a flat 30% rate on gross rent without the election where in effect the income is non-ECI. The importance of an accurate and complete tax return is that allowable reported rental losses, may in certain circumstances, be characterized as passive activity losses, applied in subsequent taxation years as well as in the year of sale to reduce adjustment gross income where a capital gain is realized on the disposition.
The filing of the annual return is generally a simple process. Without the filing, issues could arise on the sale of the property.
Interesting that IRS Form 8288 which is an information return filed to report the sale of the property by a non-resident and the remittance of the FIRPTA withholding tax on the gross sale price, does not have a specific question if the property was ever rented. In Canada, our counterpart, CRA Form T2062 has this question.