Rental Income for Nonresidents: Electing ECI Treatment and Reporting on Form 1040-NR

Introduction: Rental Income and Nonresident Aliens

Nonresident aliens (NRAs) who own rental property in the United States are subject to unique IRS tax rules. By default, rental income is treated as Fixed, Determinable, Annual, or Periodical (FDAP) income and subject to a flat 30% withholding tax on the gross amount, with no deductions allowed. However, NRAs may choose to make a special election to treat rental income as Effectively Connected Income (ECI), which allows expense deductions and progressive tax rates. This election is made and reported on Form 1040-NR.

Default Rule: FDAP Withholding on Rental Income

Without an election, the IRS taxes rental income received by a nonresident as FDAP income:

• Taxed at a flat 30% rate on the gross rental income.
• No deductions allowed for property taxes, mortgage interest, maintenance, or depreciation.
• Withholding is usually required by the tenant or property manager before payment is made to the landlord.

Example: A foreign landlord earns $20,000 in rental income from a U.S. property. Without an election, the tax liability is $6,000 (30%), even if property-related expenses are $15,000.

Electing ECI Treatment: The Advantage for Nonresidents

To avoid the harsh 30% withholding, nonresidents can elect to treat rental income as Effectively Connected Income (ECI). This election provides significant benefits:

• Expense deductions allowed: Mortgage interest, property taxes, repairs, insurance, depreciation.
• Progressive tax rates: Taxed using U.S. individual income tax brackets, potentially lower than 30% flat rate.
• Net income basis: Only net rental income after expenses is taxed.

Example: With $20,000 in rental income and $15,000 in expenses, only $5,000 net income is subject to U.S. tax — often reducing liability significantly compared to FDAP taxation.

How to Make the ECI Election

Nonresident landlords make the election by attaching a statement to their first filed Form 1040-NR. The statement should include:

• A clear declaration of electing ECI treatment under IRC §871(d).
• Identification of all rental properties in the U.S.
• Details of gross rents, expenses, and net income for each property.

Once made, the election applies to all current and future U.S. rental properties unless revoked with IRS approval.

Form 1040-NR Reporting Requirements

The IRS requires nonresidents with U.S. rental income to file Form 1040-NR. The key reporting steps are:

• Schedule E: Report gross rents, expenses, and depreciation for each property.
• Schedule NEC: Report FDAP rental income if no ECI election is made.
• ECI Election Statement: Attach to the return when first electing.
• Tax payment: Based on net income at graduated U.S. tax rates.

Publication 519 and the Form 1040-NR Instructions provide detailed examples of how to make the election and report ECI rental income.

IRS Guidance: When to File and Pay

Filing deadlines for nonresidents mirror those for U.S. citizens:

• Form 1040-NR due date: April 15, 2025, if income is subject to withholding. June 15 if no withholding.
• Extensions: Available by filing Form 4868.
• Payments: May be required quarterly if substantial tax is due.

Tax Planning Tips for Nonresident Landlords

• Always elect ECI treatment if expenses are significant compared to rental income.
• Maintain accurate records of repairs, mortgage payments, and property management fees.
• Consult IRS Pub. 334 (Tax Guide for Small Business) and Pub. 519 (U.S. Tax Guide for Aliens) for compliance.
• File on time to avoid penalties and preserve treaty benefits where applicable.

Conclusion

For individual taxpayers in the USA dealing with foreign-owned rental properties, the ECI election provides a way to reduce U.S. tax liability by shifting from a harsh 30% FDAP withholding to net income taxation with deductions. Proper reporting on Form 1040-NR, along with timely elections and documentation, ensures compliance with IRS rules while minimizing tax burdens.