1. Tax obligation for Non-residents
Individuals who are not citizens or residents of the U.S. are taxed generally only on their income from U.S. sources. Form 1040-NR is typically used to report this income.
2. Tax Treaties
Residents of countries with tax treaties with the U.S. may receive more favourable U.S. tax treatment than residents of non-treaty countries. If you take the position that any U.S. tax is overruled or otherwise reduced by a U.S. treaty, you generally must disclose that position on Form 8833 and attach it to your tax return. For more information on tax treaties see IRS Publication 901.
3. Resident or Non-Resident
IRS Publication 519 is a guide for non-residents. You are a resident of the U.S. if you hold a green card or meet the ‘substantial presence’ test. Under the ‘substantial presence’ test, an individual who spends a certain number of days in the U.S. during a calendar year (and the two preceding years) will generally be considered a resident.
4. Withholding Tax
The U.S. imposes a 30% withholding tax on certain non-business income paid to a non-resident from U.S. sources, including interest, dividends, rental income, annuity income, etc. Generally, the U.S. payor of such income must withhold the tax. Special exceptions from taxation do apply.
The 30% withholding tax does not apply if the non-resident has income effectively connected with a U.S. trade or business. Income is taxed in the same manor as a U.S. person. A non-resident will be considered to be in a U.S. trade or business if he or she conducts relatively continuous business activities from a fixed location in the U.S.
Rental income from real property located in the U.S. and the gain from its sale will always be U.S. source income subject to tax in the United States regardless of the foreign investor’s personal tax status and regardless of whether the U.S. has an income treaty with the foreign investor’s home country.
The method by which rental income will be taxed depends on whether or not the foreign person who owns the property is considered “engaged in a U.S. trade or business.” Ownership of real property is not considered a U.S. trade or business if it consists of merely passive activity such as a net lease in which the lessee pays rent, as well as all taxes, operating expenses, repairs, mortgage interest, and insurance in connection with the property. Such passive rental income is subject to a flat 30% withholding tax applied to the gross income rather than the “net rent” received.
Foreign individuals may elect to have their passive rental income taxed as if it were effectively connected with the U.S. trade or business. Once such an election is made by attaching a declaration to a timely filed income tax return, there is no obligation to withhold even in a net-lease situation.