If you are a US resident with foreign bank accounts and foreign rental property, there is a hidden twist that may radically increase FBAR penalties. This problem usually arises when an individual inherits a foreign account and foreign rental property, or owns these items prior to moving to the US.
By way of background, Treasury Form TD F 90-22.1 (often referred to as the “FBAR form”) must be filed each year by US residents and citizens who have foreign bank accounts with aggregate balances in excess of $10,000. [The FBAR form for each year must be received by the US Treasury by the following June 30. Form 8938, which requires similar disclosures, must be filed by the due date (including extensions) of the taxpayer’s income tax return.]
If you have not filed your FBAR forms on time, you may be liable for staggering penalties. For example, even if the failure to file was not willful, the maximum penalty is $10,000 per unreported account per year.
As mentioned in a prior post, IR-2012-65 provides FBAR penalty relief to many US citizens and green card holders living outside the US. But it does not help US citizens or green card holders living in the US. Instead, they are relegated to either: (1) applying for relief under the 2012 Offshore Voluntary Disclosure Program (2012 OVDP), or (2) filing the delinquent FBAR forms and requesting reasonable cause waivers of FBAR penalties.
The 2012 OVDP removes the risk of the $10,000/account/year penalty and potential criminal prosecution. But the cost of the 2012 OVDI is substantial: the penalty is normally 27.5% of the highest aggregate balance of unreported foreign accounts during the last eight years. And if there is unreported income from foreign rental property, the value of the real property is also included in the penalty base. For example, suppose the highest aggregate balance of the taxpayer’s undisclosed foreign accounts is $20,000 during the 2004-2011 period, and that the taxpayer also failed to report rents earned on foreign real property worth $100,000. Instead of a $5,500 penalty on the $20,000 of accounts, there is also a $27,500 penalty on the real property.
FAQ 36 of the 2012 OVDP provides:
Question: A taxpayer owns valuable land . . . located in a foreign jurisdiction. Must the taxpayer report the land . . . and pay a 27.5 percent penalty . . . if the property produced income that the taxpayer did not report?
Answer: [I]f the assets produced income subject to U.S. tax during the voluntary disclosure period which was not reported, the assets will be included in the penalty computation . . .
The language in FAQ 36 begs the question of whether the 27.5% penalty applies to the foreign rental property if the net income (after deducting expenses for depreciation, maintenance, interest, etc.) is zero. One interpretation is that the penalty applies unless the foreign rental activity is reported on Schedule E, even if there is a net loss. Having said that, if the rental property generated losses, one could argue that the property produced no “income subject to US tax,” and that the rental property should be excluded from the penalty base.
The standard FBAR penalty is not imposed on foreign rental property, even if the rental income was not reported. Further, as covered in a different post, the Internal Revenue Manual states that the examiner can use discretion to impose either no penalty or a reduced penalty. For example, the IRM suggests a penalty of $500/account/year may be appropriate if the violation is not willful and the aggregate accounts do not exceed $50,000. See IRM Exhibit 4.26.16-2.
US residents with FBAR penalty exposure must carefully choose between the 2012 OVDP and reasonable cause penalty waiver requests.