US Capital Gains Tax: Everything Expats Need to Know
Navigating the realm of capital gains tax can pose challenges, particularly for Americans residing overseas. Fortunately, the US government has extended several tax alleviations to lighten the load. Whether you’re venturing into stock sales or real estate transactions, this comprehensive guide unfolds everything expats should grasp about the US capital gains tax, along with strategies to reduce it.
We aim to clarify prevalent queries concerning expat capital gains taxes:
- An overview of capital gains tax
- Expats’ liability towards capital gains taxes
- Procedures for calculating and reporting capital gains
Delve deeper with us to understand the intricacies of how the US capital gains tax influences Americans abroad.
- Capital gains are profits realized from the sale of various investments, including real estate, vehicles, jewelry, stocks, bonds, and cryptocurrencies.
- The capital gains tax applies to profits made from the sale of investments, including properties, and is applicable to Americans residing abroad as per US tax laws.
- The IRS provides tax credits and exclusions that many expats can use to avoid paying a capital gains tax.
What Is the Capital Gains Tax?
To understand the capital gains tax, we need to start by defining capital gains and losses.
- A capital gain is a profit made from the sale of a property or other investment
- A capital loss is a loss resulting from the sale of a property or other investment
For example, if you bought a house for $200,000 and sold it for $250,000, you would have a capital gain of $50,000. If you sold that same house for only $175,000, you would instead have a capital loss of $25,000.
This is simply a brief summary of the concept of a capital gains tax. The actual calculations for determining a capital gain or loss are more complex. For example, you can use any improvements or repairs done to an asset to offset the capital gain amount. We will cover this in more detail below.
Capital gains and losses can apply to the sale of a wide variety of property and investments, such as:
- Real estate
Generally, any time you sell an asset for more than you bought it, that counts as a capital gain. The US government taxes these capital gains under the capital gains tax. In most cases, the rate for this tax ranges from 15%–20% based on your income level.
Do Expats Have to Pay a Capital Gains Tax?
Depending on the details of the sale, an expat may or may not have to pay a capital gains tax. Technically, all capital gains made by a US citizen are taxable. This is true regardless of whether you are selling US property or foreign property.
For example, if you sold a rental property in Florida and received a capital gain, that gain is taxable. The same would be true if you sold a home in Italy.
However, while all capital gains are taxable in theory, the IRS does provide certain exclusions and credits you may be able to use to avoid paying the tax. The two most common are the Primary Residence Exclusion and the Foreign Tax Credit.
1. Primary Residence Exclusion
If you are selling your primary residence, you can automatically exclude all capital gains up to a maximum of $250,000 if filing as single, or $500,000 if you file as married filing jointly.
You can generally only use this exclusion once every two years. For example, if you sell your current home and buy a beach house, you can exclude the gain from your current home. However, if you decide next year to sell your beach house, you won’t be able to exclude the capital gain from the sale again.
For a home to qualify as your primary residence, you must have lived in it for at least two out of the previous five years. If the home does not meet this standard, you will generally have to pay the full capital gains tax. However, there are exceptions to this rule. A tax professional can help you determine the right course of action for your specific situation.
2. Foreign Tax Credit
As an American living abroad, you may be required to pay a capital gains tax to a foreign government when selling a foreign property. Of course, this could create a risk for double taxation—being taxed twice for the same capital gain, once by the US and again by a foreign government.
US expats can utilize the Foreign Tax Credit to offset capital gains taxes by leveraging the tax relief provision that allows US taxpayers who have paid foreign taxes on their income, including capital gains from the sale of foreign property, to offset their US tax liability with the amount of foreign taxes paid.
The Foreign Tax Credit is a dollar-for-dollar reduction in your US taxes using taxes paid to a foreign country on the same income. (However, capital gains cannot be offset using the Foreign Earned Income Exclusion, as the gains are not considered “earned” income, which is a requirement to utilize this exclusion.)
By using the Foreign Tax Credit, you can protect yourself from double taxation by deducting the taxes you paid to a foreign government from your US tax bill.
Use our simple excel calculator to get an estimate of how the foreign earned income exclusion will save you money. It will make your day!
How to Calculate Your Capital Gain or Loss
1. Determine the Cost Basis of the Asset
Before you can figure out your foreign capital gain tax (or loss), you will first need to know what the cost basis for the asset is. The cost basis represents your investment in a piece of property, including both the original price and any upgrades or repairs you may have made.
For example, if you bought a home for $300,000, that would be your original cost basis. If the closing costs came to $18,000, then your cost basis would rise to $318,000. If you invested $60,000 into remodeling your home a few years later, you would add that to your cost basis as well, for a total of $378,000.
Your cost basis can also decrease over time, though this is less likely. The most common example would be a decrease due to the depreciation of a property used for business.
2. Calculate Your Gain or Loss
Once you know the cost basis of an asset, you can calculate the capital gain or loss resulting from the sale.
- To calculate a gain, simply subtract the sale price from the cost basis. In the example above, the total cost basis for a home was $378,000. If you sold that home for an even $400,000, that would give you a capital gain of $22,000 ($400,000 – $378,000 = $22,000).
- To calculate a loss, subtract the cost basis from the sale price. Using the example above again, if you sold the home for $350,000, you would have a loss of $28,000 ($378,000 – $350,000 = $28,000).
3. Factor in Exchange Rates (If Applicable)
Calculating gains or losses on the sale of US property is fairly straightforward. However, when selling foreign property, you must consider foreign exchange rates. The IRS requires converting all foreign currency amounts to US dollars before calculating gains or losses.
Since exchange rates fluctuate daily (if not hourly!), you should consider the rate before you buy and sell. The exchange rate used for both buying and selling property will be considered the spot rate for the day unless otherwise specified. In fact, gains and losses can even be created by an exchange rate difference.
For example, let’s say you purchased 100 acres of land in Germany on July 1, 2020, for 500,000 euros (EUR). You sell the land on July 1, 2021, for 500,000 EUR. At first glance, you have no gain since you sold the land for the same amount you purchased it for, but since you have to convert the euro to the dollar, this is not the case.
On July 1, 2020, the EUR-USD exchange rate was 0.896 EUR per $1 USD. On July 1, 2021, the exchange rate was 0.917 EUR per $1 USD. Now, if we use those figures to convert the 500,000 EUR you spent on your land in Germany to USD, you’ll get these results:
- Purchase price: $558,035.71 (500,000 ÷ 0.896)
- Sale price: $545,256.27 (500,000 ÷ 0.917)
When you subtract the sale price from the purchase price, you will have a capital loss of $12,779.44 US. If the post-conversion sale price had been higher than the purchase price, you would have made a taxable capital gain instead—even though the sale and purchase prices were identical before being converted to USD.
4. Determine If Your Capital Gains Are Short-Term or Long-Term
If you have any capital gains to report, you will need to know if they are short-term or long-term gains. This is based on how long you owned the asset before selling it.
- If you held the asset for one year or less, any gains made from the sale would be considered short-term gains.
- If you held the asset for more than one year, any gains made from the sale would be considered long-term gains.
This distinction is important because different tax rates apply to short-term and long-term assets. Gains from assets held for less than one year will be taxed at the same rate as your ordinary income. Long-term assets are eligible for reduced rates, which can be 15% or even 0% depending on the individual situation.
One exception to the above rule is the sale of any property that is considered “collectible.” Collectibles include items like artwork, coins, precious metals, and antiques. Capital gains made from the sale of collectibles are taxed at a 28% rate regardless of how long they have been held.
5. Report Your Capital Gains or Losses on Your Expat Tax Return
To report your capital gains and losses, fill out IRS Form 8949: Sales and Other Dispositions of Capital Assets with the details of your sale. Then, transfer that information to Form 1040, Schedule D when filing your annual tax return.
You can use your capital losses to offset your capital gains. This will reduce the taxable portion of your gains. Your capital losses may exceed the total capital gains by up to $3,000 on the tax return. Any losses over $3,000 and not claimed on the tax return can be carried forward to a future year or carried back to a previous tax year.
Still Have Questions Regarding Foreign Capital Gains? Get the Answers You Need!
We hope this guide has helped you understand how capital gains taxes impact Americans living abroad. Of course, the most common use for this information will be buying and selling property overseas. Contact us, and one of our customer champions will be happy to help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.