All Americans are required to file US taxes and report their worldwide income, wherever in the world they live. Thankfully there are a number of IRS exemptions that can be claimed to reduce or eliminate US tax liability for expats, however even if no US tax is owed, expats still have to file an annual federal return.
There are thought to be around 9 million Americans living overseas, many of whom, particularly those who have moved abroad permanently, consider purchasing foreign real estate.
It may be as a home or in some cases as an investment rental property. In this article, we’ll look at the US tax implications for US expats buying and selling real estate abroad .
Buying overseas real estate as a home or second home
While expats buying real estate abroad to use as a home (or second home) don’t need to report the purchase to the IRS, there are nonetheless still US tax implications.
Firstly, expats should be sure to retain all documents relating to the purchase, as they may be required when it comes to selling the property again down the line.
Secondly, expats who transfer funds for the purchase from the US into a foreign bank account before the purchase goes through will then have to report all of their foreign accounts by filing an FBAR (Foreign Bank Account Report), a requirement for all Americans who have over $10,000 in foreign accounts at any time during the tax year. As such, it may be beneficial to transfer funds directly from the US to the vendor, rather than to the expat’s foreign bank account first.
Thirdly, expats buying real estate abroad as a main or second home can claim mortgage interest and property taxes as deductions on their US tax return (similarly to US property).
Buying overseas real estate as a rental property
Expats buying property overseas to rent are subject to a slightly different set of rules.
While advice about retaining all documentation relating to the purchase and considering potential FBAR compliance issues still applies, as in the US allowable expenses and deductions for rental properties differ to those for homes (and second homes).
“If you use the property as a second home – not as a rental – you can deduct mortgage interest just as you would for a second home in the U.S. This includes being able to deduct 100% of the interest you pay on up to $1.1 million of debt that is secured by your first and second homes.”
Rental income must be declared on your annual federal tax return (form 1040 schedule E), and while you can’t deduct mortgage interest, you can deduct management fees, property taxes, utilities, repairs and maintenance, insurance, and depreciation.
Unlike US property however, depreciation on foreign rental property must be calculated over a 40 year period.
It’s also worth noting that expats who pay tax abroad on their property rental income can claim the Foreign Tax Credit to claim a$1 US tax credit for every dollar equivalent that they’ve paid abroad. If they’ve paid more tax abroad than they owe to the US, they can carry forward excess tax credits for future use.
Selling real estate abroad
When it comes to selling real estate abroad, the main US tax consideration for expats is capital gains tax.
Expats selling property abroad that they have lived in for at least two out of the last five years can exempt the first $250,000 (or $500,000 if they’re married) of the increase in the property’s value since they bought it from US capital gains tax liability.
Capital gains should be reported on form 1040 schedule D. Capital gains on properties that have been owned for over a year are taxed at either 15% or 20% (depending on the expat’s income tax bracket) of the value over the above exclusions.
Expats who are selling real estate abroad and who haven’t been filing US taxes from overseas can catch up on their US federal filing without facing penalties under an IRS amnesty program called the Streamlined Procedure. The Streamlined Procedure requires expats to file their last 3 tax returns and their last 6 FBARs (as required), pay any back taxes due (often none if they retro-claim one or more of the available exemptions for expats) and self-certify that their previous non-compliance was non-willful (i.e. unintentional).