For U.S. expats who own foreign rental property, one of the biggest tax decisions is whether to hold the property personally or through a foreign pass-through entity such as a foreign LLC, trust, or partnership. Many tax preparers insist that foreign rental properties held in any type of entity must file Form 8858, but that’s not always the case. In reality, structuring your foreign rental through a pass-through entity has both advantages and drawbacks, and in many cases, owning the property personally is the simpler and more tax-efficient choice.
What Is a Foreign Pass-Through Entity?
A foreign pass-through entity is a legal structure—such as a foreign LLC, foreign trust, or foreign partnership—that does not pay taxes itself but instead “passes through” the income and tax obligations to the owner. For tax purposes, the U.S. may classify the entity as a disregarded entity (if it has one owner) or a partnership (if it has multiple owners).
While an LLC in the U.S. is a common way to hold rental property, applying this strategy abroad adds complexity. Unlike a U.S. LLC, a foreign entity triggers additional IRS reporting requirements that can create headaches for expats.
Pros of Holding Foreign Rental Property Through a Pass-Through Entity
1. Limited Liability Protection
A foreign LLC or foreign trust may protect your personal assets if a tenant sues you. Some countries require foreigners to own real estate through an entity, making this the only option in certain jurisdictions.
2. Local Tax Benefits
In some foreign countries, holding rental property through a foreign corporation or LLC may offer local tax advantages. Some governments provide tax incentives for real estate businesses that own rental properties.
3. Potential for Business Classification
If structured correctly, an expat may argue that their foreign rental property is a trade or business, potentially qualifying for the Qualified Business Income Deduction (QBID), which allows a 20% deduction on eligible rental income. However, this classification is not guaranteed and depends on IRS scrutiny.
Cons of Holding Foreign Rental Property Through a Pass-Through Entity
1. Increased IRS Compliance & Reporting Requirements
Many expats don’t realize that owning a foreign rental property through an entity can trigger significant IRS reporting requirements. If your entity is classified as a Foreign Disregarded Entity (FDE), you may need to file Form 8858 annually. If the IRS considers it a foreign corporation, you may have to file Form 5471, one of the most complex and heavily scrutinized tax forms.
Failure to file these forms correctly or on time can result in steep penalties, often starting at $10,000 per missing form.
2. Many Expats Are Wrongly Told They Must File Form 8858
From my experience, many tax preparers insist that every foreign rental property must file Form 8858, even when that’s not the case. In reality, not all foreign rental properties require Form 8858. Whether or not you need to file depends on how the IRS classifies the entity, and if it is truly a Foreign Disregarded Entity. Many times, preparers automatically assume filing is necessary without reviewing the entity structure properly.
3. No Real Tax Savings for Most Expats
Unlike in the U.S., where LLCs are often used to pass through income and minimize taxes, using a foreign entity does not provide the same benefits for most expats. Since foreign rental income is passive, it generally does not qualify for the Foreign Earned Income Exclusion (FEIE). Also, tax credits on foreign property taxes and local rental taxes are still available without using an entity.
4. Higher Accounting and Legal Costs
Setting up a foreign pass-through entity often requires hiring a lawyer in the country where the property is located. Additionally, tax filing costs increase because of the extra IRS reporting requirements. This can make ownership far more expensive than simply holding the property as an individual.
Should U.S. Expats Own Foreign Rental Property Personally?
For most U.S. expats, owning a foreign rental property personally is the simplest and most tax-efficient choice. Reporting foreign rental income on Schedule E (Form 1040) avoids unnecessary IRS reporting burdens and eliminates the risk of Form 8858 or Form 5471 penalties.
If a foreign country requires you to hold real estate through an entity or if liability protection is a major concern, then using a foreign pass-through entity might make sense. However, unless there is a clear legal or tax advantage, the added IRS compliance burdens often outweigh the benefits.
Before structuring your foreign real estate investment through an entity, consult with a tax expert who understands U.S. expat tax rules—and make sure they actually check whether Form 8858 is necessary, rather than assuming it applies to every case.
