Do I Owe Tax on Currency Exchange Gains When I Sell Foreign Property?

Yes, when you sell foreign property, you may owe U.S. tax on two separate gains: the capital gain on the property itself and a Section 988 ordinary income gain from currency fluctuations on your foreign mortgage. Section 988 of the Internal Revenue Code treats gains and losses from changes in exchange rates on certain foreign currency transactions as ordinary income or loss, taxed at your regular income tax rate rather than the lower capital gains rate.

How Section 988 currency gain arises on a property sale:

• You borrow in foreign currency (e.g., a GBP mortgage on a UK home)
• Over time, the USD weakens against that currency (or the foreign currency strengthens)
• When you repay the mortgage at sale, the USD cost of repaying exceeds the USD value when you originally borrowed
• The difference is a Section 988 ordinary loss (favorable). If the USD strengthened instead, you would have a Section 988 ordinary gain

Example (UK property with GBP mortgage):

Key points:

• Section 988 gain is ordinary income, not capital gain, so it does not qualify for the lower long-term capital gains rates
• The Section 121 primary residence exclusion does not shelter Section 988 gain on the mortgage
• Foreign tax paid on the property sale may be creditable via Form 1116, but matching the credit to the Section 988 portion requires careful allocation
• No Section 988 issue if you purchased in cash with no foreign currency debt

Reporting: Section 988 gains are reported as “other income” on Schedule 1 (Form 1040), Line 8z. The property capital gain goes on Form 8949 and Schedule D separately.

For foreign property sale tax help, see our Foreign Capital Gains Guide.