Will my foreign real estate (property) be included in the calculation for the 27.5 OVDP FBAR penalty?

One issue that comes up often is how foreign real estate effects how much our clients would owe under the 2012 IRS Offshore Voluntary Disclosure Program (known as the 2012 OVDP or IRS amnesty for offshore bank accounts and assets).

In one case we had a client that had included the value of their foreign real estate in their penalty tax base when they could have excluded it, our involvement in their OVDP process saved them money on penalties the IRS may have erroneously included.

The overarching concept to an OVDP is that the current 27.5% penalty is intended to apply to all of the taxpayer’s offshore holdings that are related in any way to tax non-compliance for all assets owned by a taxpayer. Tax noncompliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.

The most important question to ask first is if the asset produced income subject to U.S. tax; if it did, the taxpayer will have to include the highest value of the property in the penalty base when calculating the 27.5 percent penalty. This is true regardless of the source of the funds used to acquire the assets.

If the property did not produce income, the second inquiry is whether the asset was originally purchased using funds subject to U.S. tax but on which no such tax was paid; if it was, the taxpayer will have to include the highest value of the property in the penalty base when calculating the 27.5 percent penalty. This is true regardless of whether the property produced income during the general eight year look back period.

These rules apply to every kind of property including property directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets; tangible assets such as real estate or art; and intangible assets such as patents or stock or other interests in a U.S. or foreign business.

If such assets are indirectly held or controlled by the taxpayer through an entity, the penalty may be applied to the taxpayer’s interest in the entity or, if the Service determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying assets.

However, the 27.5% penalty may not apply to taxpayers who are foreign residents and who meet all three of the following conditions: (a) taxpayer resides in a foreign country; (b) taxpayer has made a good faith showing that he or she has timely complied with all tax reporting and payment requirements in the country of residency; and (c) taxpayer has $10,000 or less of U.S. source income each year. For these taxpayers only, the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable income that was not reported on the U.S. tax return. If the foreign jurisdiction did not impose a tax then a taxpayer may still qualify.

Further, the following illustration may present another option for taxpayers who do not have more than $10,000 in U.S. source income, but may have no tax deficiency:

FAQ 51.1 of the 2012 OVDP entitled “under what circumstances might a taxpayer consider opting out of the civil settlement structure of the OVDP?” The following example is given by the section regarding a scenario where there is unreported income but no tax deficiency.

Example – Unreported Income But No Tax Deficiency

The taxpayer, a U.S. citizen who worked and resided in Country A, had a brokerage account in Country A that he opened in 1999. The account had a high balance of $2 million and generated income of $150,000 each year. The taxpayer did not report any of the income on his U.S. return because he mistakenly assumed he only had to report it on a Country A tax return. The taxpayer’s amended Form 1040 returns showed that, after applying the foreign tax credit for taxes paid to the government of Country A, he had no tax deficiency with respect to the unreported income. Because the taxpayer had unreported income, he does not qualify to just file delinquent FBAR reports and expect not to be investigated. However, the facts may warrant opting out of the OVDP. United States tax law allows a foreign tax credit when the foreign tax has been paid or accrued.

Vic Abajian, a former IRS tax attorney, continues to assist taxpayers with foreign account and asset issues before the IRS. As a FBAR Tax lawyer, he currently represents dozens of clients with foreign accounts both within the IRS offshore voluntary disclosure program and those that are involved in civil audits. He also represents several clients who have received grand jury subpoenas requesting information related to offshore bank accounts. Mr. Abajian has also consulted with foreign banks. To learn more about options and how to make a voluntary disclosure of an offshore bank account, please contact Los Angeles Tax Lawyer Mr. Abajian at 818-396-5059. We have offices in Irvine and Glendale, California and represent taxpayers throughout the nation and those located in foreign countries.


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