Buying a Home Abroad? Here Are the US Tax Rules You Need To Know

If you are buying a home in another country, whether as a personal residence, vacation property, or rental investment, it’s important to understand the potential U.S tax and reporting consequences. U.S. citizens and many lawful permanent residents generally must report worldwide income on their U.S. tax returns, even if they live abroad. Tax rules can follow you no matter where you live.

Given that tax law can be complex and mistakes costly, it’s important to understand how the law applies to your situation. The information below is general in nature. Consider consulting an experienced tax attorney or qualified tax professional about how the tax rules apply in your specific situation.

Does Buying Foreign Real Estate Itself Trigger US Tax?

While simply purchasing foreign real estate does not, by itself, generally create a U.S. federal income tax liability, these related activities could:

• Holding funds in a foreign bank account
• Earning rental income
• Selling the property at a gain

These activities abroad can trigger tax or reporting obligations. It is critical to understand the tax implications of buying a home abroad.

Foreign Bank and Financial Accounts (FBAR)

The Bank Secrecy Act requires you to report certain foreign financial accounts to the U.S. Department of the Treasury by filing a Report of Foreign Bank and Financial Accounts (FBAR) using FinCEN Form 114. Accounts include bank, brokerage, and mutual fund accounts when their aggregate value exceeds $10,000 at any time during the calendar year.

These reporting requirements would include accounts opened to purchase property or collect rental income. While the foreign property itself is not reportable on FBAR, the foreign financial account may be reportable.

Foreign Account Tax Compliance Act (FATCA)

The Foreign Account Tax Compliance Act (FATCA) requires certain taxpayers holding financial assets above the reporting thresholds outside the United States to report those assets on Form 8938. The filing thresholds vary depending on filing status and whether the taxpayer lives abroad.

The Form 8938 must be attached to the taxpayer’s annual tax return. Filing a 8938 is nuanced and depends on how the property is held and what related foreign financial assets exist. You will want to get assistance from a tax professional to help you understand how your home abroad could impact your obligations under FATCA.

What Is the Foreign Tax Credit?

The Foreign Tax Credit (FTC) prevents double taxation. It allows taxpayers to offset their United States tax liability, dollar-for-dollar, with tax paid to a foreign government. If your income comes only from sources within the United States, or if you do not pay any foreign taxes, you may not be able to use the Foreign Tax Credit.

The FTC can help offset passive income, such as rental income earned on a home you own abroad or dividends. It may allow you to use the tax paid to decrease what you owe in the U.S. You may be able to claim the FTC directly on Schedule 3 of Form 1040 if you meet certain conditions:

• Your total foreign tax paid is $300 or less ($600 for married filing jointly)
• All your foreign income is passive
• Your foreign tax was legally owed (it was not refunded by the foreign government)

A tax professional or tax advisor can help you determine how you may use this tax credit and how it relates to other available tax rules to reduce your taxable income.

How Does the IRS Treat Foreign Rental Income?

U.S. tax law requires all U.S. citizens and permanent residents to report their worldwide income to the IRS, including rental income from property owned abroad. This requirement applies regardless of:

• Where you live
• Where the rental property is located
• Whether you paid taxes to a foreign government
• What currency you received for the rent (if other than USD)

Reporting Rental Income

If you earn rental income on a rental property in another country, you must report the income on Schedule E of Form 1040, just as you would for rental properties owned in the United States.

Rental income cannot be excluded by using the Foreign Earned Income Exclusion (FEIE). The FEIE is the most widely used U.S. expat benefit. It allows qualifying U.S. citizens and residents living abroad to exclude foreign-earned income up to a certain amount.

Minimizing the Tax Impact of Foreign Rental Income

While FEIE does not apply to rental income because it is passive income, there are other ways to lower your taxable income. You can maximize deductions through deductible expenses for your rental property, which include:

• Management fees
• Repairs
• Maintenance
• Insurance
• Depreciation

These deductions may be able to significantly lower your taxable income. You can also use the Foreign Tax Credit to offset U.S. taxes when you pay taxes on the rental income in another country.

Can You Deduct Mortgage Interest on Foreign Property?

If you itemize deductions and the foreign property qualifies as a primary or secondary residence under applicable tax rules, mortgage interest may be deductible, subject to the same general limitations that apply to U.S. homes.

What Happens If You Sell Your Foreign Property?

If you earn profits when you sell your foreign property, you will generally need to report the gains on Schedule D, Form 8949, in US dollars, and a capital gains tax may apply.

When you sell your primary residence at a gain, you must report the sale. If the property qualifies as your principal residence and you meet the ownership and use test, you may be able to exclude up to $250,000 ($500,000 for married filing jointly).

What Are State Tax Considerations for Foreign Property?

State tax exposure usually depends on whether you are still treated as a resident for state income tax purposes, not simply whether you own property abroad.

Even if you buy property abroad, you may still be subject to state and local taxes. Some states, like California and New York, may tax worldwide income, including foreign capital gains, if you have not yet properly severed residency.

Practical Tips for Minimizing Tax on Foreign Property

There are several strategies you can use to minimize tax on foreign property.

• Hold the property you buy abroad for at least one year to qualify for the favorable long-term capital gains tax rates
• Use the primary residence exclusion when applicable
• Keep track of all improvements that can increase your tax basis in the property
• Document the exchange rates for property-related transactions
• Be aware of depreciation recapture on rental property

Consulting with a tax professional will ensure that you can consider all tax-efficient strategies available to you when buying a home abroad.

Speak with a Tax Attorney

If you need help understanding how owning foreign property affects your U.S. taxes, contact a tax advisor or an experienced tax attorney in your area. They can explain how the tax law applies to your particular situation.