The purchase or sale of a home stateside can be challenging enough. Abroad, you also have to navigate the US expat tax reporting requirements, which can be a little confusing to say the least.
As a US expat, you may already know that your worldwide income must be reported on your American tax return and this can include sale, purchase and rental transactions of foreign property.
The US tax system is an unusual model whereby it taxes based on citizenship and not residence like almost every other country in the world.
There are many factors to consider when buying a home overseas, such as foreign mortgages, exchange rates, and market conditions to name a few. Conversely, when selling a home abroad, rental properties for example have different tax rules than selling a primary residence.
Americans living abroad are required to report and pay US tax on gains from foreign property sales. The US Foreign Tax Credit may be able to offset paying capital gains tax both in the US and abroad on income generated from the sale of a foreign home. In this article we will take a look at the purchase and sale of foreign property, and the implications in relation to your US expat taxes.
Buying Property Abroad
Buying property abroad for the most part does not require reporting on your expat taxes. If however you rent out your property, you will need to file schedule ‘E’ (form 1040) to report income or loss from rental real estate. Another scenario when you might have had to report the purchase of a home is if you claimed the First Time Home Buyer Credit for the related year of purchase during 2008, 2009 and 2010. In subsequent years, a repayment of the credit was required depending on the year in which the home was purchased, and if you stopped using the property as your main home.
Buying real estate in a foreign country can create different tax reporting the US. Estate taxes may be triggered, and it is imperative that you research local laws and regulations including tax and insurance requirements in your new home country abroad.
It is often advantageous to open a local bank account abroad to assist with payments for mortgages and property taxes or receive rents. Moving large sums of money internationally will require you to be aware of exchange rates, to ensure you get the most favorable rate and potentially save thousands of dollars. Another very important consideration though is that if you have foreign financial accounts with balances that combined exceed $10,000 at any point during the calendar year, you will required to file the Report of Foreign Bank and Financial Accounts (FBAR)
“If you are a U.S. citizen with income from dispositions of property outside the United States (foreign income), you must report all such income on your tax return” – the IRS
Mortgage interest points are deductible regardless of your property’s foreign location. You will need to convert this data to US currency when you report it, however.
Your expat tax professional will also be able to advise you on buying property in a holding corporation. The theory is that if you put a property abroad into the name of a company rather than your own name, then should you sell the property or should you die you don’t transfer the property but instead simply transfer the company to the new owner. This can potentially save costs, which in many foreign jurisdictions, can be surprisingly high. Some types of overseas holding corporations will make it harder to qualify for gain exclusion, so it is important to talk to a US expat tax professional before deciding. Furthermore, if your property is in a holding corporation, you will need to file the onerous Form 5471, or you may elect to report it as a disregarded entity by filing Form 8858.
Selling property abroad
The sale of a property abroad must be reported on your US expat taxes. In the same way if you sold a home in the US, selling a home abroad may require you to file IRS Form 8949 and a Schedule D (and a Form 4797 for rentals) . Any capital gain made from the sale is considered foreign income, and, as stated earlier, the US is one of the few countries to tax US citizens on their worldwide income. Since you may also owe taxes abroad, to avoid paying capital gains taxes in both countries, you may be able to claim the US Foreign Tax Credit which offsets income tax paid to other countries.
Sales of a Principle Foreign Residence
A principal residence abroad is any property you have lived in for at least two of the last five. When you sell your principal residence, you are eligible for a gain exclusion of $250,000 USD, or $500,000 USD for married principal owners. If you don’t qualify for the gain exclusion, any gain will be considered foreign income and thus eligible for the Foreign Tax Credit. This income is not considered foreign earned income and will not qualify for the Foreign Earned Income Exclusion.
The value of the mortgage that needs to be repaid at the time of sale, is converted to US Dollars based on the spot exchange rate as on the date of repayment, and is compared to the US Dollar value based on the exchange rate on the date the mortgage was borrowed. If the value of the mortgage being repaid is a lower amount, the difference is taxed as an ordinary gain under IRC Section 988, whereas a foreign exchange loss is not deductible.
Sale of Foreign Rental Properties
When you sell a rental property abroad, the IRS taxes the property in two different ways.
Capital gains tax may be applicable, and also depreciation recapture tax rate of 25%.
If you sell your foreign property, you may be able to make a 1031 exchange (also called a like-kind exchange), in which you swap one investment property for another “like-kind” property on a tax-deferred basis.
Many investors use this strategy to defer paying capital gains and depreciation recapture taxes.
However, a significant difference in the tax treatment of domestic property vs. foreign property is that property in the U.S. is not considered like-kind to any property overseas. U.S. Internal Revenue Code Section 1031 allows only domestic-for-domestic and foreign-for-foreign exchanges. IRS Tax Tips
The U.S. considers any property outside the U.S. to be like-kind with any other similar property outside the U.S.
Sales of Inherited Foreign Property
Almost all the same conditions apply to your US expat taxes on sales of inherited property as in the states, except your gains are calculated as any gain you made over the original amount the property was worth on the day the decedents passed (the fair market value).
Considering all the Facts
If you are planning on buying, selling or renting a home abroad it’s a good idea to fund reputable local advice, to help you understand local laws, inform you of any additional costs charged by government agencies, and property tax rules. Use due diligence to protect yourself by seeking advice from an expat tax professional. In this way you can ensure the transactions and ownership of foreign property is conducted in a manner that protects your rights and bank account.