[Taxanswers]

Is backup withholding required if a US citizen living abroad borrows $1.3 million from, and pays interest to, a NRA and purchases a commercial property in the US with the proceeds?

What if there is a co-borrower living in the US?


Where would the US citizens take the deduction on their tax return?


What is the best structure to hold the property, C corp (no/little taxable income), S corp, LLC, individually?


Having read many of the related threads here, as well as the Housden case that IntlTax recommended, I suspect withholding is not required, but of course reading Pub 515 made me unsure.


Your help is much appreciated.

[AtlantaTaxExpert]

Any mortgage interest payment to a NRA requires backup withholding unless the NRA provides Form W-8BEN to claim an exemption under the applicable tax treaty.

The fact that the co-borrower is in the U.S. is irrelevant.

The mortgage interest is deducted on the corporate return if the property is managed under a C or S corporation.

If the property is under a LLC Or individually, it most likely is reported under Schedule E, though Schedule C can be used in some cases.

Tax-wise, the LLC is simpler and DOES provide some litigation protection, but I believe the S corporation is the best management vehicle.

[Taxanswers]

Thanks, ATE. Below is an excerpt from a thread you and IntlTax were on a few years ago. Can't the message below be understood to mean that a citizen living abroad is not subject to backup withholding?


Referenced Quote:
"This is because the sourcing rule is based on residence. If the person who owes the money (the “obligor”) resides in the U.S. the interest is U.S. source income. On the other hand, if the person who owes the money (the “obligor”) resides outside the U.S. the interest is not U.S. source income. Only U.S. source income is subject to the withholding tax. Thus, what Five Rings stated is correct.

This rule applies regardless of where the property is located. Sourcing for interest is not based on where the mortgaged property is located. Instead, source for interest is based on where the person who owes the money resides. The regulations under section 861 support this. Treas. Reg. § 1.861-2(a) provides in part:
(1).. . [I]nterest from a resident of the United States on a bond, note, or other interest-bearing obligation issued or assumed or incurred by such person shall be treated as income from sources within the United States.. .
(2) The term "resident of the United States", as used in this paragraph, includes (I) an individual who at the time of payment of the interest is a resident of the United States.. .
Chart B on page 14 of Publication 515 is consistent. The chart is titled “Summary of Source Rules for FDAP Income.” The chart states that “IF you have.. . Interest.. . THEN the source of that income is determined by.. . The residence of the payer.. . ” On page 15 of Publication 515, it states that interest is one of the types of “FDAP income.”

[AtlantaTaxExpert]

I believe the citation in question was for a foreign national who was a resident alien.

YOU are a U.S. citizen, and, as such, your location is irrelevant.

[Taxanswers]

I contacted PwC located here and they believe that the interest paid to the NRA is not subject to backup withholding. I am getting so many conflicting opinions, I do not know what to do??

[Taxanswers]

There is a reference in the quoted text to what "Five Rings stated." I searched long for what that was but could not find it. Would you know what that reference was to?

[AtlantaTaxExpert]

No, I do not know that reference.

I know Five Rings personally, so send him a Private Message and I will email him to log on to answer.

No guarantee that he will, but I will email him..

[Taxanswers]

Look forward to hearing from Five Rings, too. Thanks for all your help.

[AtlantaTaxExpert]

Just sent him via email the text of your question and the link to this posting; hopefully he will answer!

[Taxanswers]

I sent Five Rings a message earlier today. Looking forward to get to the bottom of this Q.

[AtlantaTaxExpert]

TaxAnswers,

It turns out you are correct; there is NO tax withholding. See extract below from Five Rings email to me:

No backup withholding. Look to secs. 871(a)(1)& 1441(a). The source is WITHOUT the US since the payor is not within the US. This has nothing to do with any treaty; it is US domestic law.

[Taxanswers]

Great. I'll check the references, too. Really appreciate your help!

[AtlantaTaxExpert]

Glad to help!