Guest post by John Ohe, IRS Enrolled Agent and chartered Financial Analyst.
In this article, we discuss U.S. expats and real estate. The most frequently asked questions on this topic include: (1) what are the tax implications when buying foreign real estate? (2) I still own real estate in the U.S. – what are the key issues to consider?
Buying Foreign Real Estate
From a tax standpoint, buying and selling foreign real estate is not much different than in the U.S. Currently, there are no reporting requirements when purchasing foreign real estate. However, U.S. expats should be aware that if one transfers money to a foreign bank to facilitate a real estate transaction (and the balance exceeds $10,000), then this would trigger a requirement to file an FBAR (FinCen 114).
Property taxes are deductible on your tax return. So are mortgage interest payments, including home equity loans. The same restrictions apply as in the U.S. (e.g., acquisition debt limited to $1M, home equity debt limited to $100,000). One can deduct mortgage interest on up to two homes. Keep in mind that deductible amounts paid in local currency will need to be converted to USD for tax reporting purposes.
When it comes to selling foreign real estate, the tax-related similarities continue. If the home has been one’s primary residence for at least 2 out of the past 5 years, then one can exclude capital gains up to $250,000 ($500,000 if married filing jointly). Similar to the real estate deductions, amounts denominated in local currency will need to be converted to USD.
From a non-tax standpoint, there are a number of issues to consider. Property rights differ by country. Transferring money should be conducted carefully – fees and Foreign Exchange transactions can be costly. It may be wise to seek professional guidance (e.g., a reputable real estate broker).
Holding onto U.S. Real Estate
Many Americans are aware of the $250,000 ($500,000 if married filing jointly) exclusion on the gain from a sale of a home in a qualifying transaction. The following general requirements must be met to qualify for the exclusion:
- Person must have owned and occupied the home as a principal residence for at least 2 out of 5 years prior to the sale; and
- During the two-year period ending on the date of the sale, the person did not exclude gain from the sale of another home.
What is lesser known is the fact that any portion of the gain attributable to non-qualified use of the property is ineligible for the exclusion. Non-qualified use includes periods during which the property is not used as an individual’s principal residence (including when it is rented out). The maximum exemption amount is reduced on a pro-rated basis
Let’s use a simplified example to illustrate. Jane Smith (a single taxpayer) buys a house for $100,000 on January 1, 2000. She lives in the house for five years, then moves abroad. On January 1, 2012 (seven years later), Jane returns to the U.S., and begins living in her house again. On January 1, 2014, she sells the house for $350,000 (at a gain of $250,000). Jane meets both of the above requirements. However, 7 of the 14 years she has owned the house falls under non-qualified use. Therefore, only half (or $125,000) of the maximum exemption amount applies. Jane will have to pay capital gains tax on $125,000.
There is one important exception to the non-qualified use rule. Non-qualified use does not include any portion of the 5-year period preceding the sale that is after the last date that the property is used as a taxpayer’s principal residence. In plain English, if you own a home and leave the U.S. without selling the property, sell it within 3 years (and don’t move back into the home). That way, you qualify for the 2 years of 5 years requirements, and you will not be subject to a reduction in the maximum exemption amount.
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All responses are provided by John Ohe (IRS Enrolled Agent and Chartered Financial Analyst).
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Disclaimer: The answers provided in this article are for general information, and should not be construed as personal tax advice. Tax laws and regulations change frequently, and their application can vary widely based on the specific facts and circumstances involved.