Get to know the authorFor different reasons, many Americans dream of buying a home overseas.
Some want to escape the hectic lifestyle of the US and spend their last days relaxing and tanning on the beaches of Punta Cana.
Others see it as an investment opportunity and want to use the foreign property as a source of passive income on Airbnb.
But while buying a home overseas might come with bragging rights, it also comes with tax obligations. This blog post covers some of the most common questions we get from our Bright!Tax clients about purchasing a home overseas.
Do I need to declare the purchase of a foreign home to the IRS?
US expats don’t have to declare the purchase of a home overseas to the IRS since they won’t be making any income. However, if they decide to sell the home at any given time, then they need to report the gains or losses on Schedule D of their US tax return.
That’s why we recommend keeping all of your property-related documents throughout the ownership of your foreign home. If you do decide to sell your house, you’ll need documents such as the proof of earnings from the home and any costs you invested in improvements.
I inherited a home overseas. Do I still have to report it to the IRS?
If you eventually end up selling the home, the same rules will apply if you eventually end up selling the property.
In addition, if the home that you inherited is worth more than $100,000 and the decedent was not a US citizen or resident, you would also be obligated to file Form 3520 (Reporting Foreign Trusts, Inheritances, and Gifts for Americans Abroad).
What are the tax implications of buying a foreign home?
Your new home country’s local taxes and laws will significantly impact your home purchase. For example, many countries require you to purchase your new home within a holding corporation instead of buying the house in your name. This has implications in that you are now a US citizen who owns a foreign corporation in which other forms are needed.
The costs involved in buying a home (such as hiring a real estate agent and legal advisors) will also vary from country to country and can quickly add up. That’s why you should work with a trusted tax advisor who can help you find ways to save the most money possible when buying a foreign home.
If you’re purchasing a home that used to belong to someone else, you may have to pay a transfer tax. Again, the transfer tax will differ for each country, but you can expect to pay around 1% to 10% in taxes. If you’re planning to buy an expensive house, the transfer tax is something you want to consider before going all in.
Also, mortgage and interest may also still be deductible on your US tax return regardless of the location of your foreign home. The type of deductions and amounts will depend on whether you are using the home as your primary residence or as an investment property. If you purchased the house in a different currency than USD, you’d need to report this information on your tax return by converting the mortgage to claim these deductions.
For more information on how to do that, read our past article on how to use IRS exchange rates for your tax return.
What are the tax implications of selling a home?
Based on whether you had gains or losses with the sale of your foreign home, you’ll have to declare the sale to the IRS. And depending on how much time you spent in your foreign home, you could qualify for some tax exclusions from the IRS.
If you lived in your foreign home during at least two of the previous five years, you can exclude up to $250,000 from taxes ($500,000 for married expats). If you lived less than two years in your foreign home, then the IRS will tax the sale of your home at capital gain rates. Any taxes that you are paying in the local country can be used to offset these gains as mentioned below.
How do I file the sale of my foreign home?
Filing the sale of your foreign home is similar to reporting the sale of a home on US soil. To do so, you’ll need to file the IRS Form 8949 and a Schedule D as well for any rental properties you own. In some cases, you might also have to file Form 8938 (Statement of Specified Foreign Financial Assets).
Do I still have to report a foreign property that’s depreciating?
Even if the value of your foreign home is depreciating, you still have to report it to the IRS. However, the IRS depreciates foreign real estate with a different depreciating system than domestic properties. The depreciable life of foreign properties is between thirty and forty years.
Does the sale of my foreign home qualify for the Foreign Earned Income Exclusion (FEIE)?
The IRS’s Foreign Earned Income Exclusion (FEIE) program helps American expats reduce their tax liability and avoid double taxation. The maximum income the IRS allows you to exclude is $112,000 ($108,700 for the 2021 tax year) and the figure rises each year due to inflation.
To qualify for the program, expats must pass either the Physical Presence Test or the Bona Fide Residence Test.
Read more: How to Claim the Foreign Earned Income Exclusion – Instructions for Expats
Unfortunately, the gain you make from selling your foreign home won’t qualify for FEIE since the gains on sale are not considered “earned” income but rather fall into a category of passive income However, the sale of your home does qualify for Foreign Tax Credits (FTC), which reduces your tax liability by one dollar for every dollar you already paid in foreign taxes.
Read more: Claiming the Foreign Tax Credit vs. the Foreign Earned Income Exclusion
Do I need to file a Report of Foreign Bank and Financial Accounts (FBAR)?
The Report of Foreign Bank and Financial Accounts (FBAR) is an IRS document that American expats must file if they possess more than $10,000 across foreign bank accounts.
For example, let’s say you have $6,000 in a Chinese bank account and another $6,000 in a French bank account. In this case, since you possess over $12,000 worth of assets across different foreign bank accounts (which is above the threshold of $10,000), then you’ll need to file an FBAR.
To buy a home in your new home country, you’ll typically have to transfer the funds from your US bank account to a foreign bank account, so you can make the purchase. And I bet you a hundred bucks that it’s probably going to be more than $10,000.
In this case, you’ll have to file an FBAR report when purchasing your new home. If you don’t want to go through the hassle of filing an FBAR, you can hire a tax advisor to manage the reporting for you instead.
What are the tax implications if I decide to rent out my foreign home?
Some US expats may decide to purchase a foreign home, not to live in but to rent out, and to make some passive income on the side. If you choose to go in this direction, you’ll need to declare your foreign rental income on Form 1040 Schedule E.
The IRS has four different tax treatments for foreign rental income. Your tax treatment will vary based on the number of days that you lived in or rented out the property:
- – Rental property: The owner spent no days living in the home and rented out the property for 1 – 365 days in the tax year.
- – Vacation home and rental property: The owner spent less than 15 days living in the home and rented out the property for more than 15 days in the tax year.
- – Vacation home and secondary residence: The owner spent more than 14 days living in the home and rented out the property for more than 15 days in the tax year.
- – Not reportable: The owner spent more than 15 days in the home and rented out the property for less than 15 days in the tax year.
If you pay foreign taxes on the rental income of your overseas property, you’ll be able to qualify for Foreign Tax Credits, which we mentioned above. Other things about your foreign rental that you can deduct from your US tax return include insurance, maintenance costs, management fees, and repairs.
If you plan on renting out your foreign home, we recommend hiring the right team of CPAs that fully understand US expat taxes and your IRS obligations. The team of accountants will handle all the filing for you, so you can start renting out your foreign home and have complete peace of mind.
Have any more questions about buying or selling property overseas?
For many, buying a home overseas may seem like a dream come true and a major milestone to aim for in life. However, it doesn’t mean that you should forget about your tax obligations.
If you’re planning to purchase a home in another country and still have questions about compliance with the IRS, Bright!Tax is here to help. Our team of tax professionals can help you better understand your reporting requirements so you can start your foreign home purchase on the right foot.
Contact us today to learn more about our services.
