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Expat Tax Essentials
Moving overseas is a stressful process. When you add in buying property abroad, things only get more complicated. There are a lot of factors involved in buying foreign property, such as:
…and, of course, taxes. This guide looks at US expat taxes on foreign property and what they mean for you.
All US citizens must file a yearly tax return regardless of where they live in the world. When filing your return, you must report your worldwide income. This includes any gain or loss from selling a foreign property and rental income.
For the most part, the rules for reporting this income are the same regardless of whether the property is located in the US or overseas. Still, there are details that Americans living abroad need to know.
First, let’s consider the tax implications of buying property abroad. Generally speaking, you do not have to report the purchase of property—whether foreign or domestic. (One possible exception to this is if there is a Homebuyer Credit in place for that year.)
However, you will probably have to obtain a foreign bank account when buying property abroad. This will help with the following:
You may have to file an additional US tax form in this case. US citizens with at least $10,000 deposited in one or more foreign bank accounts must report it by filing FinCEN Form 114, better known as the Foreign Bank Account Report (FBAR).
When transferring money to your foreign bank account, be aware of the foreign exchange rates and fees associated with the transfer. When making the initial down payment on your foreign property, you could be transferring significant sums of money. Good research and enlisting the help of a professional broker could save you thousands of dollars by ensuring that you use the most beneficial foreign exchange rate possible.
Of course, when you sell the property, you will need to report the gain or loss based on the original cost. For this reason, you must keep all documentation from the original purchase and any other costs associated with buying property abroad.
Real estate transactions in foreign countries are handled differently than US transactions and may accrue estate taxes. Always research applicable laws and insurance requirements for your new host country.
Consult with the US embassy in your host country for assistance regarding local laws, property taxes, and other requirements before purchasing your new property.
Costs charged by government agencies, real estate agents, or legal advisors may be significantly more than in a US real estate transaction. These expenses vary from country to country. Researching and planning can help you save big on your US expat taxes.
Mortgage interest and points will continue to be deductible on your US expat taxes, despite the property’s location in a foreign country. However, this information needs to be reported in US dollars, so converting the amounts is essential before claiming the deduction.
For assistance in preparing your US tax return, the IRS provides annual foreign exchange conversion rates for numerous countries and links to a reputable third-party website with more detailed historical information.
In many countries, buying your property through a holding corporation rather than in your name is customary. Some types of overseas entities will make it much harder to qualify for the gain exclusion. If the host country has different options for the kind of holding corporation you can use, consult a US tax advisor before making the decision.
You may have additional US tax obligations when purchasing the property through a business entity. US citizens with non-US financial assets valued above certain thresholds must file a FATCA report. The threshold will depend on your filing status.
Selling property abroad will have a much more significant impact on your US expat taxes than buying. As a US citizen, the sale of your principal residence—regardless of where it is—will prompt a gain or loss that is reportable on your tax return.
However, if you have owned and lived in this home for at least two of the last five years, you will be eligible to exclude a gain of up to $250,000 ($500,000 for married taxpayers) from taxation. If you have not owned and lived in the home for at least two out of the last five years, the gain will be taxed at capital gain rates.
Even if the gain does not qualify or is not wholly excluded, it will be considered foreign source income and thus eligible for the reduction by the Foreign Tax Credit. However, it will not be regarded as foreign-earned income and, therefore, not excludable under the Foreign Earned Income Exclusion.
To calculate the gain, each transaction must be converted to USD on the transaction date rather than the sale date. All income must be reported in US dollars on US expat taxes. Report your gain or loss on Schedule D of your income tax return.
The other important transaction likely to result from the sale of a foreign residence is the gain or loss resulting from the foreign exchange rate conversion when the mortgage is paid off. The currency exchange gain or loss resulting from the payoff of the mortgage is considered personal. Thus, any resulting loss is not deductible.
However, any resulting gain is taxable at ordinary income rates. If you have held the property for at least a year, you will qualify for the lower long-term capital gain tax rates. Unfortunately, you cannot use the loss on the sale of the home to offset any currency exchange rate gain and vice versa.
To help explain how to calculate the capital gains tax associated with selling your foreign real estate, let’s discuss the sale of John Expat’s primary residence outside the US.
John moved to China in 2005, where he immediately began searching for a home to purchase. He found one, and on November 17, 2005, he signed the papers to buy his new home. He paid 1,865,000 Chinese Yuan (CNY) for the property on the date of sale. On May 25, 2007, he spent 50,000 CNY for new windows on the house.
In 2011, he decided he wanted to move back to the US to spend time with his family and put his house on the market. He signed the closing papers on June 24, 2011, with a sales price of 2,010,000 CNY. At that time, he had 1,725,000 CNY left to pay on his mortgage.
Each transaction is converted to USD at the date the transaction occurred:
Because John owned and lived in the property for at least two of the last five years, he is eligible to exclude the entire gain associated with the sale of his principal residence.
The other transaction that results from the sale of his principal residence is the gain or loss resulting from the currency exchange. This is calculated as follows:
It will take more USD to pay off the foreign mortgage than initially anticipated at the date of purchase. The result is a net loss of $52,785. Unfortunately, this loss is not deductible on John’s US expat taxes.
The total impact on John’s US expat taxes resulting from the sale of his principal Chinese residence is zero. He can exclude all gains associated with the sale of the property, and he incurred a loss on the currency exchange associated with the mortgage payoff, which cannot be applied to his other foreign income.
If you receive any rental income from a foreign property, you will also have to report that on your income tax return. You can apply the same tax deductions to rental income from a foreign property as a property in the US. These deductions include:
As with any other foreign income or gain, you must report it as US currency. This will generally require a conversion process.
When selling a rental property, the taxes will likely be more complex than when selling a home or other personal property. For example, the tax you owe on any gain may be impacted by the following:
If you don’t own the rental property outright (as is somewhat familiar for foreign rental properties), your tax filing requirements may become even more complicated. In this case, you will likely have to file Form 5471.
If you are buying a residence overseas, you should discuss your options with your host country’s US embassy, consult multiple international real estate brokers, and discuss your options with an expat tax expert like Greenback.
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