Us tax treatment of Indian capital receipts

[mendu]

My wife and I are Indian citizens with US permanent residency. My wife owns an apartment in India. The building that the apartment is in, is being redeveloped by a builder. Duirng the redevelopment project, my wife does not have access to that apartment. Therefore, the builder is required to  pay her monthly compensation to cover her cost of an alternate residence during the project. The Indian government has ruled that such compensation payments are capital receipts and are not taxable in India, irrespective of whether the money is actually used for rent or any other purposes. Would the US tax code consider these payments as capital receipts or regular income? If they are capital receipts, how should we handle them in Turbo Tax while paying US taxes? Thank you.

[AmyC]

I am going to assume you are discussing a situation covered by article 6 of the tax treaty and it would be taxable income.

As a US resident, you would report all worldwide income. If the income is exempt from taxation, it would come back off and you would either:

• use Form 8833 to claim the exemption. The form is in the program. 
• do not have to file Form 8833 for any of the following situations:

1. The payee can claim a reduced rate of withholding tax under a treaty on interest, dividends, rent, royalties, or other fixed or determinable annual or periodic income ordinarily subject to the 30% rate.
2. The payee can claim a treaty exemption that reduces or modifies the taxation of income from dependent personal services, pensions, annuities, social security and other public pensions, or income of artists, athletes, students, trainees, or teachers. This includes taxable scholarship and fellowship grants.
3. The payee can claim a reduction or modification of taxation of income under an International Social Security Agreement or a Diplomatic or Consular Agreement.
4. The payee is a partner in a partnership, or a beneficiary of an estate or trust and the partnership, estate, or trust reports the required information on its return.
5. The payments or items of income that are otherwise required to be disclosed total no more than $10,000.

However, I am not convinced that this income falls under the treaty, I am not a US -India treaty expert but lean towards this being taxable income under article 6. 

Reference:

About Publication 901, U.S. Tax Treaties 

[mendu]

Thank you so much for your reply. Very helpful!

I had  a couple of follow-up questions -

1. In this case, the current building is being torn down. A new one is being built in its place. Until the new one is built, my wife will get these compensatory rent payments, in lieu of her inability to reside in the building and under the assumption she has to pay for alternate accomodation. Would she be able to claim a US tax exemption for these payments? As I mentioned earlier, the Indian government considers them to be tax-exempt in India.

2.   My wife had to incur significant legal costs, when she discussed and signed the redevelopment contract with the builder. If we have to pay tax on the rent payments, how do we handle the legal costs? Would the total rent payments be reduced by the legal costs? Or would the legal costs be added to the total cost basis of the apartment, if and when she sells it?

Thank you once again. I really appreciate your advice.  

[AmyC]

1. In the US, additional living expenses (ALE) are paid by insurance companies and not taxable when related to being displaced from your home. However, I don't know if this is a second home or a rental. If it is  a rental property, then income from an investment would be taxable income. 

2. Expenses would add to the basis for a second home. If you are using a Sch E rental for the apartment, you can include those expenses on your Sch E.

[mendu]

1. Thanks so much for your response. This is a 2nd home and not a rental. We have not had any rental income from it in the past and do not intend to offer it on rent in the near future. Since we live most of the year in the US, we were not exactly displaced when the buiding in India was torn down. How does that impact  the tax treatment of the compensatory payments? Thanks again.

[AmyC]

As a second home, it would not be taxable income since it is for living expenses.

[chelgeetha]

My situation is slightly different - my company has paid compensation for loss of value due to subsidiary spin-off towards ESOPs that I hold now. My India CA is clear we should treat this payment as capital receipt and pay tax in India whenever I exercise corresponding ESOPs - not this FY. How do I report this income in current year's US tax return? Can I postpone such reporting whenever I settle this in India (e.g., exercise of ESOPs)? Thanks