Maximizing US Tax Deductions for Foreign Real Estate Investments 

Maximizing US Tax Deductions for Foreign Real Estate Investments 
Updated on April 24, 2024

Every type of real estate transaction has tax implications. Carefully managing them is critical for foreign investments to prevent unwanted tax issues. The transactional tax problems in purchasing real estate or businesses outside the US can be notably intricate.  

Questions about tax obligations under the US system and how to comply require a lot of analysis and planning. Additionally, assuming they don’t have to pay taxes is a common mistake among Americans overseas.  

Whether within the country or abroad, you’re required to pay taxes to the Internal Revenue Service (IRS). Therefore, understanding how taxes work if you have a foreign real estate investment property is critical. It will empower you to make better-informed financial decisions.  

Here, we’ll discuss how foreign real estate investments are taxed in the US and what the possible tax breaks are.  

Tax Implications of Foreign Property or Investments in the US 

Investing in real estate overseas can be a potentially rewarding venture. But it also involves potential risks, making planning critical. 

Depending on the purpose of your real estate purchase, some lenders may offer mortgages. Thus, you must understand the eligibility criteria before deciding to refinance a mortgage or invest in foreign real estate.  

Likewise, understanding how foreign property or investments are taxed in the US is imperative. Since every country has different tax laws, owning property overseas provides distinct opportunities and challenges, whether for personal use or investment reasons.  

In the US, the tax implications of investing in foreign real estate will differ based on whether you use the property as your primary residence or an investment asset. Here are the essential tax considerations you must know when dealing with foreign property or investments in the US:  

Foreign Real Estate Ownership as an Individual

The IRS requires American citizens to submit a complete and accurate tax return annually, even if they live abroad. That’s because the US is one of the few countries that tax individuals based on citizenship instead of location.  

However, the reporting requirements for foreign real estate ownership are contingent upon the nature of your ownership. Suppose you’re the direct owner of a property outside the US, meaning you own it as an individual. You don’t have to report the foreign real estate to the IRS as long as it is properly used for personal reasons only and no income has been earned from it.  

Selling the property will generally be something required to be reported on your tax return. In addition, rent collected from the property is required to be reported on your US tax return, regardless of where the property is located.  

Typically, the income is reported on Schedule E of Form 1040. It’s designed specifically for reporting rental income and expenses. You must provide accurate and detailed information about each foreign property you own, including its type, location, and income earned.  

Foreign Real Estate Ownership as an Entity

Purchasing a foreign real estate entity, such as a corporation or trust, is common among American citizens. The Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to report assets owned by US account holders.  

Likewise, FATCA mandates American citizens and residents, both domestically and abroad, to file annual reports and pay any taxes on any foreign account holding they have.  

It also outlines several reporting thresholds for US taxpayers with foreign financial assets. You must report foreign real estate on Form 8938 if the assets surpass a specific value.  

Under Section 1.6038D-2 of the Internal Revenue Code (IRC), those with foreign real estate filing individually must report their assets if they exceed the following thresholds:  

  • $200,000 at the end of the tax year and living outside of the US if not filing jointly. If filing jointly, double this amount. If living in the US, change this amount to $50,000 if not filing jointly or $100,000 if filing jointly. 
  • $300,000 at any point during the tax year and living outside of the US if not filing jointly. If filing jointly, double this amount. If living in the US, change this amount to $75,000 if not filing jointly or $100,000 if filing jointly. 

Failing to file Form 8938 can result in a penalty of $10,000. You can incur an additional penalty of up to $50,000 if you fail to file promptly after IRS notification.  

How To Maximize US Tax Deductions on Foreign Real Estate 

Expanding your portfolio into international markets can be appealing. However, extra caution with tax planning and details is vital for the overall profitability of your investments.  

As mentioned, how you use overseas property can influence the benefits you obtain under US tax law. Consider the following factors to maximize your tax deductions on foreign real estate investments in the US.  

Depreciation Methods 

Depreciation can substantially reduce an individual’s income tax liability in the US. It involves deducting a fraction of the property’s cost yearly until you recover the entire amount.  

Generally, there are two different portions of assets in real estate: land and structure. Land is considered to last forever and, therefore, is never depreciated. In contrast, a structure is not considered to last forever, and depreciation expenses are allowed for the “wear and tear” of the property over time.   

As long as it’s categorized as an investment property, you can depreciate the value of your foreign property’s structure or improvements on your income tax return. Unlike US property, foreign real estate adheres to different rules.  

Under Section 168 of the IRC, the alternative depreciation system must be employed for any tangible property primarily used outside the US during the taxable year. Typically, depreciating foreign residential property occurs over 30 years. Foreign commercial property also follows a similar process, except it depreciates over 40 years.  

Expense Deductions 

You can claim expense deductions on your foreign real estate property. The cost you can deduct on your US tax return depends on whether you use it as a residence or a rental property.  

Suppose you live in an overseas property. Like your home in the US, you can deduct mortgage interest and discount points on your foreign residential property. You can also claim the home office deduction if you operate any business out of your home.  

However, like a primary residence, you can’t write off home-related expenses on your taxes, such as utilities, maintenance, or insurance, unless you qualify for the home office deduction. Likewise, you can’t deduct foreign property taxes for tax years 2018 through 2025.  

Moreover, you can claim deductions for mortgage interest to any reasonable expenses related to your foreign rental property. Remember, you must divide your expenses between rental and personal use if you occasionally use the rental property for personal purposes.  

1031 Like-Kind Exchange

Another way to maximize tax deductions on your foreign real estate property is the 1031 like-kind exchange. It allows you to postpone the payment of capital gains and depreciation recapture taxes by reinvesting proceeds from one property sale into another.  

However, this strategy is only effective when you sell foreign property and reinvest the sale proceeds in new foreign property. It’s worth noting that property in the US isn’t considered like-kind to any property overseas.  

That means you can’t sell US property and utilize the proceeds to buy foreign property. Section 1031 of the IRC permits only exchanges between properties within the same country or those similar properties in foreign countries.  

This transaction must only be sensible from an investment perspective. It can be possible if the country where you’re selling the property doesn’t impose capital gains taxes. If it does, claiming a credit for taxes paid in another country is likely more beneficial.  

Foreign Tax Credits 

You can also offset the US income tax you owe by the taxes you paid or accrued to a foreign country on investment property. This can help prevent double taxation on the same income you earned.  

When you claim foreign income taxes as a credit, it can lower your US tax liability. Suppose you run a rental property business overseas. You can avoid being taxed on the same income by taking a tax credit on your domestic taxes for expenses you incurred in the foreign country.  

Alternatively, you can write off the foreign income taxes you paid as itemized deductions. This strategy lets you reduce your taxable income in the US, helping you save money on taxes. Yet, claiming the foreign taxes as credit is advisable in most cases.  

Navigating the complexities of US tax implications for foreign real estate investments requires expert guidance. Thoroughly assessing possible risks and compliance requirements is critical for maximizing tax benefits while avoiding penalties associated with non-compliance.  

You can confidently navigate these intricacies with the assistance of an experienced tax professional like Greenback Expat Tax Services. Besides protecting your assets and enhancing financial outcomes, they can ensure compliance with international and local laws. 

Every expat should know these 25 things about US expat taxes. Find out for yourself.
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