All Americans have to file US taxes on their global income, wherever in the world they live.
Many American expats own rental property, either in the US or overseas. The way foreign rental property is treated for US tax purposes is different compared to US rental property though.
Rental Property Depreciation for Expats
Rental Property Depreciation allows Americans to reduce the amount of US tax that they pay on rental property income.
According to IRS rules, a residential rental property in the US has a ‘useful life’ (i.e. a depreciation period) of 27.5 years. This means that expats who have a US rental property can deduct the initial cost of the property divided by 27.5, each year for the first 27.5 years of renting.
Let’s look at an example of a US rental property that is worth $300,000, with annual rental income of $30,000, and annual rental expenses of $10,000.
Allowable expenses are listed in Form 1040 Schedule E, where property rental income is reported.
So the property owner can exclude $10,000 of allowable expenses, plus depreciation calculated as the value of the building divided by 27.5, so $10,909, of the rental income from US tax, leaving just $9,091 of taxable rental income.
“The IRS tax rules for depreciating foreign rental property are different than U.S. properties.” – Golding Lawyers
Foreign rental real estate however uses the alternative depreciation system, which is calculated slightly differently.
The difference is that foreign rental property depreciation is calculated over 30 years, rather than the 27.5 used for US property.
So a foreign rental property bought for $300,000 with annual rental income of $30,000 and allowable annual expenses of $10,000, a further $10,000 (the value of the property divided by 30) can be deducted for depreciation, leaving a slightly higher figure of $10,000 of taxable rental income.
For non residential foreign rental property, depreciation is calculated over 40 years, rather than 30.
How expats can avoid double taxation for foreign rental property
Many expats with foreign rental property have to pay foreign taxes on their rental income in the country where the property is and/or the country where they live.
Expats who pay foreign taxes in another country on their foreign real estate rental income can claim US foreign tax credits up to the same value as the foreign taxes that they have paid.
To claim the Foreign Tax Credit, expats must file IRS Form 1116 when they file their US federal tax return from abroad.
Many other countries have higher tax rates than the US and no depreciation system, so if expats pay more foreign tax than the US tax that they owe, they can apply the excess US tax credits to other income sources, or carry them forward for up to ten years, or back a year.
Expats who have US rental properties on the other hand can’t claim the US Foreign Tax Credit to offset foreign taxes paid on their rental income, however most other countries allow expats to claim tax credits based on the US income tax they’ve paid.
Expats should always seek specialist US expat tax advice before filing from abroad, as filing US taxes from overseas is complex. Expats who are behind with their US tax filing and foreign financial account reporting can catch up without facing penalties under an IRS amnesty program called the Streamlined Procedure, including claiming the US Foreign Tax Credit in retrospect.