Foreign Real Estate Sales and Capital Gains Tax
Let us pose a couple of hypotheticals for you. Perhaps you have family members living outside the US, and you’ve just inherited some property abroad. Maybe you travel internationally as a US expat and decide to buy real estate as an investment. Maybe you were looking for a home away from home.
Whatever the reason, if you’re a US resident or expat who owns property in another country, it’s important to understand the potential US tax reporting requirements associated with your foreign real estate.
Building on this idea now… what happens if you decide to sell this property? You might be wondering, “Will I owe capital gains taxes to the IRS for real estate sold outside of the country?” No worries – we’re here to break down the basics and outline US tax concerns to keep in mind (for your own peace of mind!).
The Basics: If You Sell Property, You Must Report It to the IRS
First thing’s first, no matter where the property is located, if you sell real estate, the IRS requires you to report it on your US tax return. So, whether you’ve sold a house in Alabama or in Rome, the IRS wants to know about it.
Depending on your individual circumstances, the IRS might also require you to pay capital gains tax on the sale of your home.
What is Capital Gains Tax and How Much Will You Owe?
Capital gains refer to the profit you make when selling an asset that appreciates in value over time, such as a house. In the US, you owe capital gains tax when you sell certain assets, including overseas property.
How much you’ll pay in capital gains tax depends on how you used the property and how long you owned it. Let’s explore this concept a bit further by providing a few examples below.
Example 1: What if I Sell My Primary Residence?
If the property was your primary residence and you lived there for 24 out of the last 60 months, you’re eligible for a capital gains tax exclusion. The IRS specifies in Section 121 that you can exclude up to $250,000 in capital gains from taxation. If you’re married and file a joint tax return, this increases to $500,000.
Let’s say you’re a US expat who lived abroad in Iceland for the past three years in a home you purchased in 2019. If this home is your primary residence and you lived there for at least two out of the last five years, you can qualify for this exclusion. So, if you bought the house for $300,000 and sold it for $450,000, your profit (read: capital gains) would be $150,000. This profit is less than the capital gains exclusion, so you would not report your home sale on your US tax return.
There are some exceptions that still allow you to take the capital gains exclusion (or part of it) if you don’t meet the 24/60 month rule, however. If you had to sell your house because of unforeseen circumstances – such as a divorce, change of employment or change in health – you may still be able to claim a partial or full exclusion.
Example 2: What if I Sell a Rental Property?
If you owned the property for less than one year, the IRS considers this a short-term capital gain, and you would report this on Section I of Schedule D. The IRS would tax you at your ordinary tax bracket, meaning the rate that applies to other types of ordinary income (ex. your wage, or interest income).
Capital gains on rental properties owned for more than one year are treated a little differently. In order to figure out the tax on the sale of a rental property, you’ll need to:
- Determine your cost basis, which includes the original purchase price, purchase expenses (like title and escrow fees), improvements or renovations
- Adjust for the accumulated depreciation you reported (or should have reported) on all tax returns filed during your ownership of the property
These numbers together are considered the Tax Basis on your property.
Next step: subtract the Tax Basis from the proceeds of the sale. If the resulting number is positive, it means you profited or generated a gain on the sale and you may owe the US capital gains tax. In this case, you would be taxed partly on the amount you earned on the sale and partly on the amount of depreciation you claimed on the home, in what’s called a “depreciation recapture”.
If the number is negative, you did not make a profit and you would not owe any capital gains tax, because the sale resulted in a loss. Your loss may be deductible to offset other income you have on your tax return.
Example 3: What if I Sell Another Type of Property?
There are of course other ways to own property aside from a primary residence or a rental property, such as a vacation home or an investment property.
If you own a property for more than one year, it was not your primary residence, and you did not rent it out, you could owe the long-term capital gains tax, which ranges from 0-20% but you are only eligible for a tax deduction when you sell the property for a loss if it was considered a capital asset, not a personal use asset (ex. a vacation home).
How to Report the Sale of Foreign Real Estate to the IRS and FinCEN
The way you’ll report your home sale to the US depends on the location and country of the property, as well as whether the money from the sale was deposited into a US bank account. If you received foreign currency for the home sale, for instance, you would have to use the foreign exchange rates associated with the different key figures (ex. date of purchase, date of renovation, sale date) and report in US dollars on your tax return.
To report your foreign property sale, fill out Form 8949, Sale and Other Dispositions of Capital Assets, along with a Schedule D. If you sold a rental property, you may also need to fill out Form 4797, Sale of Business Property.
If the profits from the sale of your foreign home were deposited into a foreign bank account, you would likely have to note it on your Foreign Bank Account Report (FBAR), which you file using FinCEN Form 114. Form 8938 will also be required if you’ve hit the relevant reporting thresholds. [link out to 8938 article]
Read more: IRS Capital Gains Tax for US Expats
Other Tax Considerations When Selling Property Abroad
You’ve likely gathered so far that buying property overseas as a US expat is complicated. In some cases, the best way for Americans to purchase real estate in a foreign country is by forming a limited liability company (LLC), partnership, or corporation and then making the purchase.
US-based LLCs by default pass their income, including long-term gains to their members, meaning you report the capital gains on your personal income tax return and apply your personal capital gains tax rate. Limited liability companies registered abroad, however, are reported differently to the IRS, including the possible requirement of submitting Form 5471, Information Return of US Persons With Respect to Certain Foreign Corporations, or other complex foreign corporate disclosures.
Foreign Real Estate Sales Can Be Complicated: Bright!Tax Makes Them Simple!
If you’re a US expat who recently sold foreign property, navigating your US tax return for this year may seem overwhelming. Different reporting requirements depend on how long you owned the property and if you lived in it or not. Figuring out how much you owe in capital gains taxes can also be confusing.
Bright!Tax can walk you through the IRS and FinCEN reporting requirements, check to see if you’re eligible for any exclusions, process your returns for you, and answer any questions you have along the way!