In a prior blog post, I referenced a New York Magazine article revealing how foreign real estate investors use LLCs (limited liability companies) to anonymously buy real estate in New York City. This game could be impacted however by recent IRS rule changes that would require single-member LLCs whose member is a foreign citizen to report to the IRS.
IRS Issues New Reporting Rule Affecting Single-Member LLCs Owned by a Foreigner
On December 13, 2016, the IRS passed a new regulation that requires single member LLCs, which have elected to be disregarded entities for tax purposes and whose member is a foreign citizen, to be treated as a corporation for the limited purposes of certain record-keeping and reporting purposes, even if the foreign owner doesn’t have any tax reporting obligations. This new regulation affecting reporting is effective for tax years commencing after December 31, 2016.
This regulation, amending 26 CFR 1 & 26 CFR 301, forces foreign investors to satisfy certain record-keeping and disclosure requirements. Likewise, transaction costs rise because affected LLCs will need to consult with tax advisors to ensure compliance.
New Regulation Makes LLC Structured Investments More Expensive
Furthermore, disclosure could dissuade foreign investors from purchasing domestic real estate through LLC vehicles. Those foreign investors who have already purchased property through an LLC or use LLC vehicles for other investments will need to consult tax attorneys in order to avoid non-compliance with the new reporting requirements. Separately, a tax opinion may be necessary in addition to a legal opinion when foreign persons use domestic LLC investment vehicles. These additional regulatory reporting requirements add costs and could impact the demand for New York real estate, which has been getting gobbled up by foreign investors and typically through single-member LLC vehicles.
In the abundance of caution, foreign owners of single-member LLC should immediately consult their tax attorney to discuss how these regulations impact their holdings.
Hypothetical Scenarios Applying the New Regulation
The IRS included in its treasury decision (TD 9796) the following two hypothetical scenarios applying the new regulation:
Example 1.
(i) In year 1, W, a foreign corporation, forms and contributes assets to X, a domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 2, W contributes funds to X. In year 3, X makes a payment to W. In year 4, X, in liquidation, distributes its assets to W.
(ii) In accordance with § 301.7701-3(b)(1)(ii) of this chapter, X is disregarded as an entity separate from W. In accordance with § 301.7701-2(c)(2)(vi) of this chapter, X is treated as an entity separate from W and classified as a domestic corporation for purposes of section 6038A. In accordance with paragraphs (a)(2) and (b)(3) of this section, each of the transactions in years 1 through 4 is a reportable transaction with respect to X. Therefore, X has a section 6038A reporting and record maintenance requirement for each of those years.
Example 2.
(i) The facts are the same as in Example 1 of this paragraph (b)(9) except that, in year 1, W also forms and contributes assets to Y, another domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 1, X and Y form and contribute assets to Z, another domestic limited liability company that does not elect to be treated as a corporation under § 301.7701-3(c) of this chapter. In year 2, X transfers funds to Z. In year 3, Z makes a payment to Y. In year 4, Z distributes its assets to X and Y in liquidation.
(ii) In accordance with § 301.7701-3(b)(1)(ii) of this chapter, Y and Z are disregarded as entities separate from each other, W, and X. In accordance with § 301.7701-2(c)(2)(vi) of this chapter, Y, Z and X are treated as entities separate from each other and W, and are classified as domestic corporations for purposes of section 6038A. In accordance with paragraph (b)(3) of this section, each of the transactions in years 1 through 4 involving Z is a reportable transaction with respect to Z. Similarly, W’s contribution to Y and Y’s contribution to Z in year 1, the payment to Y in year 3, and the distribution to Y in year 4 are reportable transactions with respect to Y. Moreover, X’s contribution to Z in Year 1, X’s funds transfer to Z in year 2, and the distribution to X in year 4 are reportable transactions with respect to X. Therefore, Z has a section 6038A reporting and record maintenance requirement for years 1 through 4; Y has a section 6038A reporting and record maintenance requirement for years 1, 3, and 4; and X has a section 6038A reporting and record maintenance requirement in years 1, 2, and 4 in addition to its section 6038A reporting and record maintenance described in Example 1 of this paragraph (b)(9).
Nothing herein shall be considered tax advice. Before acting on any information or filing a return, please seek the advice of competent tax counsel.
