In the past month, the Internal Revenue Service has announced two new audit campaigns targeting overseas investors who own or hold interests in U.S. property.
The campaigns focus on foreign investors selling their interests in U.S. real estate and those who receive rental income from their American properties.
The IRS generally expects to collect 15 percent of the amount a foreign seller realizes off a transaction, though exceptions can be made if the property is sold at a loss or the price is under $300,000, among other factors. The taxes the IRS collects from foreign investors earning rental income ranges depending on how the property is owned, but can go up to 30 percent annually.
Audit campaigns began in 2017 as a way for the IRS to target issues it determines to be at a high-risk of noncompliance. The campaign issues also represent areas where the federal agency believes it has a good chance of recovering unpaid taxes.
When the IRS debuted the strategy, it announced 13 campaigns, a number that has since ballooned to nearly 60. Though the number and focus of the audit campaigns fluctuate over time, tax professionals take heed because once a target is announced, businesses and clients operating within that area have a higher likelihood of having the IRS dig through their returns.
The IRS declined to comment on the new campaigns or its expectations for funds recovered from foreign investors.
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William Kambas, a tax partner at Withers, said the agency’s new property investor-focused campaigns are a factor of the pandemic.
“The restraints and constraints on the government now financially has put a new focus on collecting whatever is due,” Kambas said. “Now is the time that the IRS has decided to pursue more rigorous audits.”
The IRS’ aggressive strategy will likely hit the mid-market institutional, private equity investors the hardest, said Kenneth Dettman, a managing director at tax firm Alvarez & Marsal.
Another group that may particularly feel the crunch is foreign investors who own second homes in markets where property values have soared during the pandemic, such as South Florida.
In recent months, Dettman said he’s seen an influx of overseas clients looking to sell their U.S. homes in such markets — and many aren’t aware the IRS levies a tax on the sale, which is indicative of a larger problem.
“From the perspective of foreign persons investing in the U.S., there is a general sentiment that they’re foreign and they’re not subject to the U.S. tax net,” he said. “Their fear of enforcement activity is not very high and therefore they’re very quick to turn a blind eye to it.”
He said the new audit campaigns will likely work hand-in-hand with the IRS investigating the history of a property being sold by a foreign investor to ascertain whether they collected rent.
Most overseas landlords and their stateside tenants deal in all-cash transactions without any rental platform as a middleman, Dettman said, so the IRS has no visibility into the rental income generated off a foreign-owned U.S. property unless it undertakes a major audit.
Vasiliki Yiannoulis-Riva, a real estate partner at Withers, agreed. “There’s a lot of money to be made,” she said. “They’re not actually collecting what they could be collecting.”
According to CBRE, investment in U.S. commercial real estate accounted for nearly half of the global volume in 2019, despite more than half of foreign investors pulling back on pouring money into the U.S.
Not everyone’s concerned, however. Michael Kosnitzky, a partner and co-leader of Pillsbury Winthrop Shaw Pittman’s private wealth group, said the IRS campaigns confounded him.
“I’m just surprised that there’s such a gross lack of compliance,” he said. Kosnitzky’s clientele includes institutional investors and ultra-wealthy individuals, who he said come with a phalanx of lawyers and accountants hired to ensure compliance.
There are also doubts about the agency’s ability to execute. In recent years, the number of audits conducted by the agency have fallen. Of the audits that were conducted by the large business division, only about half closed without the agency collecting any additional revenue, according to a report released earlier this year.
If the IRS can follow through, however, Dettman believes the audits have the potential to change attitudes among mid-level property investors.
“The results of bad audits find their way into social circles in clusters in foreign countries,” he said. “[If there are] audits that come out with very harsh results, I do think it could instill a bit more fear.”