Foreign Rentals for Expatriates
When expats attempt to rent their property in their foreign home, they must be sure that they are complying with the tax laws of said foreign country (which may be very different from the US laws). Additionally, they must report all foreign rental income on their US tax return. In most ways, the laws for reporting foreign rental income as the same as US based properties. There are a few differences, however.
Rental properties owned in your name (not a business name) will be reported via Schedule E of Form 1040. The allowable deductions are the same for foreign property as they are for US property.
If you are unfamiliar with these deductions, they include management fees, property taxes, interest, maintenance, repairs, HOA dues, depreciation and other various expenses involved in renting property.
Differences between foreign rental property and US is that the depreciation of the property is based on a forty year period instead of the US 27.5 years.
Expats are allowed to take a credit against their US taxes if they have paid rental taxes to their foreign country. The credit is limited based on the amount of US taxes you have paid on your rental property. The good news is that unused foreign credit can be carried into the future. The majority of US states do not allow credit for foreign taxes, however. Also note that rental income will not be eligible under the foreign earned income exclusion.
If you own property in which you live for a portion of the year and rent for a portion of the year, the same restrictions and deductions apply. But you will not escape taxation at the time of sale by using a tax free 1031 exchange. Under this code section, foreign properties will not be eligible.
When and if the property is sold (and considering it is in your name), the net gain will be taxed by the US at capital gains rates. You can claim a US tax credit based on taxes you paid on the profit to your foreign country.
If you lived in your foreign home for two of the previous five years (immediately prior to the sale), you will most likely be allowed to exclude up to $500,000 ($250,000 if single) of the gain from your US taxes (this means you will owe absolutely no taxes if you gain less than this amount). You will exclude this amount because of the exclusion for the sale of personal property.
The above is all relevant to personally owned property. If the property in question is held by a foreign corporation, there are US tax consequences while renting and when selling. However, certain types of foreign corporations all but eliminate US tax problems. These types of corporations only affect taxes in the US, however, and no not affect the way the company is taxed in its country.
Owning foreign property does not, in itself, require special form. Additional forms might be required based on the set-up and operation of the property, however.
Related US Tax Forms
Form 8865: This form is used if your property is owned through a foreign partnership (considering you own at least 10%). This form must be filed each year alongside your tax return.
Forms 3520/3520A: If your foreign rental or residence is held in a foreign trust, both of these forms must be filed each year. However, they are not filed alongside your return but are due on March 15th and October 15th. The penalties for failing to file these forms are severe.
Form 5471: If your foreign property is owned by a foreign corporation, you will be required to file if you own 10% or more of the company’s shares. This form is due on October 15th. The IRS may penalize you up to $10,000 per year for not filing.
Form TDF 90-22.1: This is the form you use to report your foreign bank and other financial accounts. This would include the account in with your foreign rent payments are being deposited. You are only required to file this form if your combined accounts total at least $10,000 at any point during the year. If you are required to file, this form is due (to the Treasury) on June 30th. The penalty for failing to file this form is $10,000. In a few countries (for example, Costa Rica) the titles to all real estate are held through a foreign corporation. You are required to report ownership in these foreign corporations on Form TDF 90-22.1
I.J. Zemelman, EA is the founder of Taxes for Expats