In announcing its 2011 Offshore Voluntary Disclosure Initiative, the I.R.S. indicated its intention to intensify prosecution of those who fail to meet their Foreign Bank Account Reporting requirements after the program is over. For those who have overseas real estate holdings, it is important to understand what a taxpayer needs to report on his or her income tax returns, or declare on an FBAR, and what he or she would need to disclose as part of the OVDI with respect to their real estate.
Reporting Foreign Assets
The I.R.S. requires any "United States person" who has signatory authority over or any financial interest in an account in a foreign jurisdiction to file a Report of Foreign Bank and Financial Accounts form if the aggregate amount of all the foreign accounts exceeds $10,000 in a calendar year. A U.S. person is any U.S. citizen, resident, green card holder, tax resident, partnership, corporation, estate or trust.
Additionally, the I.R.S. demands that those filing income tax returns in the U.S. report all sources of foreign income, including income generated from real estate that the taxpayer owns in foreign jurisdictions. Thus, if a taxpayer earned income from the sale of overseas real estate he or she would need to report that income. Likewise, if a taxpayer earns income from rental property in a foreign country, the I.R.S. requires that he or she report that income.
FBAR, OVDI and Real Estate
In February 2011, the I.R.S. announced its 2011 Overseas Voluntary Disclosure Initiative, an effort to gather previously uncollected taxes on U.S. taxpayers' undisclosed foreign assets. In exchange for the I.R.S. not pursuing criminal penalties for tax evasion and levying hefty civil fines, taxpayers can become current with the I.R.S. by disclosing their offshore assets to the I.R.S., paying back taxes plus interest on the assets, and paying a penalty of 25 percent of the highest amount of the value of the overseas accounts.
The I.R.S. announced that the "offshore penalty is intended to apply to all of the taxpayer's offshore holdings that are related in any way to tax non-compliance, regardless of the form of the taxpayer's ownership or the character of the asset."
This means that if a taxpayer had funds in an offshore account that the taxpayer never disclosed to the I.R.S. - but should have - and then used some of those funds to purchase real estate overseas, the taxpayer would need to include the value of the real estate when calculating the 25 percent penalty on the aggregate amount of overseas assets as part of OVDI - even though the taxpayer would not have had to file an FBAR for owning offshore real estate had he or she purchased it with funds that the I.R.S. had already known about.
In complying with the 2011 OVDI, a taxpayer ends up needing to disclose more than he or she would if he or she had filed an FBAR in the first place. This is because the I.R.S. definition of "foreign account" - even though seemingly all-encompassing - does not apply to real estate, art or other similar assets.
I.R.S. regulations and definitions for the 2011 OVDI are filled with potential pitfalls for the unwary. Contacting an experienced tax attorney to assist in the process can help avoid costly mistakes.
