Paying the correct amount of tax is our responsibility to the government. Taxes come from the earnings or income a person earns through employment, business, or investments. When you own a rental property and make money from the rent, you have to pay taxes for it. In the US, income for leasing out your property is taxable.
Property Lease Tax in the US: FDAP vs. ECI
At the federal level, income generated from a property lease is treated as an investment income. Non-residents may choose to classify their rental income as an Effectively Connected Income (ECI) or as a Fixed Determinable Annual Periodical (FDAP) income.
Doing business in the US as a foreigner, fixed or regular incomes are generally considered as FDAP income. Following this, foreign investors earning rental income must pay a 30% withholding tax. This tax is levied on the gross amount and does not accept deductions, credits, or personal allowances.
Should the taxpayer choose to classify the rental income as an ECI, progressive tax rates apply after allowable deductions. Note that this is only applicable for profit earned from rental properties.
What You Should Know When Owning a Rental Property in the US
When you have a property in the US and intend to rent it out, here are things you should know:
You should first identify if your property is a formal rental property or a residence that is open for temporary rental. Here are three categories of rental properties in the US:
Tax-Free Rental. These properties are rented out for 14 days or less annually. If yes, then this article is not for you since you do not have to pay property lease tax for incomes generated from short-term rentals. You may not claim this income against your taxes provided that your rates used a fair market rate. You also have to make sure that you live in that property for more than 15 days annually.
Personal Residence. This property type means that you use the property for more than two weeks or about 10% of the total days the property was rented out, whichever is greater. Based on the IRS, this property is more of a personal residence rather than a rental property. For instance, you rent out your property for 190 days. You must use it for 19 days or less for the property to be classified as a personal residence.
Rental Property. If you are renting the property out for more than 15 days and use it for less than 14 days or 10% of the rented days, then it is a true rental property. The IRS requires that you report all income and related expenses on the property. If you are losing money from this property, you can carry over these losses to your personal income.
The Bottom Line
Note that the days spent on improving the rental property does not count as personal use. For instance, you spend two days cleaning or repairing the rental house. You cannot count those days as personal use for it to qualify as a rental property.