Most law-related information on the web comes with a disclaimer towards the end. When discussing foreign real estate and offshore disclosure, though, I would put the disclaimer at the very beginning: It is strongly suggested that you talk to an attorney with experience in this area.
Why at the beginning? Because I want to emphasize that if you own foreign real estate and are considering the Offshore Voluntary Disclosure Program (OVDP) or its “lite” version, the Streamlined Filing Compliance Procedures (SFCP), you should speak to an experienced lawyer as early as possible in your decision-making process. The area is complex, and an early misstep can wind up costing you far more than necessary.
Below I will outline some key facts about what makes foreign real estate reporting so complex and potentially costly, but remember that none of it should be considered individual advice. There are several ways to get your portfolio of foreign assets compliant, but choosing the one that will cause the least financial pain requires individual analysis.
Foreign Real Estate “Dressings” Are Reportable
Let’s start with your reporting obligations. Real estate, in the context of offshore asset disclosure, is a lot like lettuce in a salad for dieters. The main ingredient won’t get you into trouble. It’s the dressings you need to watch out for.
How it works is that if you hold the title to a piece of foreign real estate (i.e. it is under your name as an individual) then you do not need to report it at all. So understanding your reporting obligations is easy. You don’t have any.
On the other hand, if you were to have any “dressings” with your foreign real estate, e.g. a corporate holding structure, rental income, or a foreign bank account where you receive that rental income, you have had an obligation to disclose them. Another way to think about it is that if you have done something with your property apart from simply owning it in your name, then that “something” most likely has triggered a reporting requirement.
(For more information on where you may need to make your disclosures, please see an article I wrote on the most common tax forms for U.S. citizen expats. If you have not been fulfilling your reporting requirements, then you should get up to speed, and ways of doing so are via either the OVDP or SFCP. Both options are for U.S. citizens who need to disclose foreign assets. You can read an overview of the most recent regulations here.)
The OVDP is Particularly Harsh on Foreign Real Estate Holders
Let’s assume that you own (directly, under your own name) a rental property in Mexico for which tenants have been making monthly rental payments into your Mexican bank account, and you did not disclose either the rental income or the existence of the bank account.
As stated above, you have several ways of getting compliant. The thing is, though, in all your options except the OVDP, you may be subject to penalties on the previously unreported income and bank account, but the total value of the property will not come into play. In other words it won’t matter if the sticker price of the property is $50,000 or $500,000; what will matter is that the property was generating foreign income that was going into a foreign bank account.
In the OVDP, however, the sticker price of the real estate is included in your assets for the purpose of calculating the 27.5% penalty, provided that the real estate was “related in any way to tax non-compliance,” as the IRS indicated in FAQ #35 on their website. What is even more painful is that the IRS does not take into account mortgages or other encumbrances on the property. If you have a $490,000 mortgage on a $500,000 property, you would owe penalties on the whole $500,000.
Put another way, in the OVDP you will be penalized for the value of real estate that is non-reportable (anywhere outside of the OVDP, at least), and which you may not actually own free-and-clear. I’m sure you can see why the OVDP may not be an ideal fit for you if you have significant foreign real estate holdings, especially if they are leveraged.
You Should Get Compliant, but You Will Probably Prefer to Opt Out of the OVDP
As mentioned earlier, apart from going through the “full version” OVDP, you can apply for the “lite version” SFCP or even consider what’s called a “qualified quiet disclosure,” which means that you will enter the OVDP but then opt out before the process is complete. You can find more information on your various options in that OVDP overview article I wrote.
The thing to remember is that if foreign real estate is a relatively large part of your non-compliant portfolio, you will probably be better off opting out of the OVDP and choosing another way, even if that other way is not perfect. For example, making a qualified quiet disclosure does have an element of risk, but it will, in all likelihood, cause less financial painful than simply agreeing to a 27.5% penalty on the value of your property holdings.
Let’s say you are a successful (but non-compliant) real estate investor with several mortgaged foreign commercial properties with a corporate holding structure and a foreign bank account for each. In the OVDP, those two non-compliant “dressings” will trigger penalties on everything including the sticker price of the mortgaged properties. If you will be wiped out by the OVDP penalties, it’s reasonable to attempt to avoid them by making a qualified quiet disclosure. That way you would, hopefully, pay only non-compliance penalties on the “dressings” but not the underlying assets.
Don’t Take a Huge Financial Risk; Have an Expert Review Your Case
By now you can see that when foreign real estate is involved, which disclosure route you take can make a big difference in your final tax bill.
I would like to highlight that even if a particular route seems to have been laid out for you (even in a notice letter from the IRS), it is prudent to get a second opinion from an experienced attorney. Your disclosure case will be the first time you come into contact with this particularly complex (and frequently updated) set of rules and regulations. An experienced attorney will have already been in the trenches and will likely see ways to help that you probably will not see for yourself.