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Capital Gain Tax on Sale of Foreign Real Estate

Capital Gain Tax on Sale of Foreign Real Estate
Ines Zemelman, EA
08 April 2022

If you are a US Expat living and working overseas, the chance is high that you will wind up selling property in a foreign country.  When you sell property (whether in the United States or in a foreign country), you will be responsible for capital gains taxes.  There are some additional steps you need to take when calculating the capital gains tax you owe to the United States for property sold in a foreign territory. Foreigners selling property in USA has the same impact if it would have been done by a US citizen.

You will report capital gains on Schedule D.  Exchange rates will come into play after you sell foreign property.

In order to accurately calculate your amount of loss or gain from selling foreign property, you need to look up the exchange rate active at the time you purchased the property and the exchange rate for the time in which the property was sold.  Everything needs to be converted to USD (US Dollars).

If you sell a property abroad do I pay tax?

Selling houses abroad: If you lived in the house you sold for at least 2 years out of the previous 5 years, it is considered to be your primary residence.  When you sell your primary residence, you qualify to take a deduction of $250k from any gains you had on the sale of a home.  If you are married, this amount doubles for a total available deduction of $500K.

If your foreign property did not qualify as a primary residence, you will be subject to the standard capital gains tax rates

If the foreign property you sold is regarded by the IRS as an investment property, you will need to pay the standard capital gains tax rate without any deductions. This can lead to higher tax brackets based on the amount of gain realized which will be taxable in the tax year.When selling property abroad, different kinds of residences and properties have different kinds of reporting requirements and tax specifications. Tax on selling property can differ based on the type of property you sold. For example, selling an overseas rental property has different tax rules than when you sell an overseas primary residence. you may also owe Foreign capital gain taxes to the country in which the overseas property lies, but you may be able to avoid paying capital gains taxes to both countries by claiming the foreign tax credit, which is a dollar-for-dollar credit on taxes paid to one of the countries.

U.S. taxes on sales of inherited foreign property: All the above conditions apply to U.S. taxes on sales of inherited foreign property, but you may have an extra step. Once a decedent passes, an inherited foreign property often receives a stepped–up basis, which is the property’s fair market value on the date the original owner passed away or deeded the property to you. Once that’s converted into USD, your capital gains would be any income you made over that original amount. Not all inherited property is treated exactly like this — it depends on the way the property’s ownership was structured.

U.S. taxes on sales of foreign rental properties: If you’re selling a property which produces forein rental income, any gain you realize may be taxed at multiple different rates, depending on the amount of your overall gain, your holding period, and the amount of depreciation claimed on the property. Reporting requirements and U.S. overseas capital gains tax on foreign properties gets more complicated if you do not own the property outright (which is somewhat common for overseas rental properties). If this sounds like your situation, another form you may have to file is Form 5471 (if the foreign property you’re selling is held by a foreign corporation). 

This information only applies to your US expat tax return.  You may be liable for local taxes in your host country – in which case, you may qualify to reduce your US capital gains tax liability by claiming the Foreign Tax Credit.

If you have capital gains on overseas assets, the foreign country in which you reside, you may be able to offset your US capital gains tax liability by claiming a dollar-for-dollar deduction using the Foreign Tax Credit. If you need help calculating your amount of capital gains or losses, you are encouraged to seek the assistance of a qualified US expat tax professional.

Non-Resident Sells Property Abroad, Becomes Resident

Situational analysis: A resident in the UK (Mike B - a foreign person) purchased a home in the UK in 1998 and the purchase price was $100,000 USD, selling it 20 years later for $600,000, resulting in a capital gain of ~$500,000. Coincidentally, Mike moved to the U.S in July 2017 on an L visa.

QUESTIONS TO CONSIDER

1.    Does MIke owe any tax to the U.S?

2.    If Mike owes tax, on what amount is it calculated?

3.    What, if any, are Mike’s options to mitigate this unfortunate situation?

Cost Basis - is step-up an option?

What is Mike’s cost basis? Is it $100,000 (1998 cost), or can he use the ‘step up’ basis?

Step up basis, allows the taxpayer to ‘recalculate’ the cost basis not from the date of purchase, but from a new date in the future. Unfortunately, in general, this is not an option for a non-US person immigrating to the U.S.

SOME POSSIBLE WAYS TO PLAN THE TIMING OF INCOME RECOGNITION INCLUDE  

  1. Obtaining a step-up in basis before US residency begins by selling and reacquiring the house. It is a costly option because the owner would incur various transaction costs. However, if the property has had high appreciation it is the option to consider.
  2. Selling a foreign residence before US residency begins, to avoid US tax on any gain. This is the simplest option, if Mike is certain he does not want to hold this property any longer.

Remain UK tax resident - claim closer connection to foreign country

Publication 519 contains the following statement: "If you are treated as a resident of a foreign country under a tax treaty, you are treated as a nonresident alien in figuring your U.S. income tax." So, if he remains resident of UK, he can still be treated as an NRA (non-resident alien) in the U.S.?

STEPS TO TAKE  

1. Claim closer connections to the U.K on Form 8840 and file a non-resident return for 2018

2. In order to do so, Mike must spend less than 183 days in the US in 2018 and not to have applied for green card.

3. This combination Form 8840 + 1040NR may allow him to avoid reporting capital gains on the home.

Does not meet closer connection test- last option form 8833

If Mike has either spent too much time in the U.S., or applied for a green card (invalidating the form 8840 tests), a less reliable option is for Mike to file Form 8833 and exclude the sale of property as a treaty benefit while filing form 1040.

This is the last resort if  he does not qualify for closer connection through form 8840.

Form 8833 has this little loophole on Page 48 of Publication 519.

Reporting Treaty Benefits Claimed: You receive payments or income items totaling more than $100,000 and you determine your country of residence under a treaty and not under the rules for residency discussed in chapter 1.

If income from home sale was reported on 1042-s, 1099 or any other US form this claim would be impossible. But for a non-US property gain this may work.

Ines Zemelman, EA
Founder of TFX