Buying foreign real estate is far more complex than buying a second home in Flagstaff.

Tax impacts of buying real estate in a foreign country

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Debra Callicutt, CPA, MBA

Whether you are an expat living in a foreign country or just an investor from the U.S. purchasing a foreign property, your foreign purchase will give rise to increased tax reporting obligations, local country compliance and potentially more matters to consider as compared to purchasing a U.S. property.

Personal Use

If purchasing the foreign property for personal use, you should consider:

How will you title the property?

  • Will you hold the property in your name, hold it jointly or use a trust?
    • You should seek legal and tax advice from advisors in the foreign country and the U.S. to determine how the property will be taxed in both countries with respect to gift and estate tax.

Will the property have a mortgage?

  • Assuming you itemize, the foreign mortgage interest you pay during the tax year can be deducted as an itemized deduction on Schedule A.
  • Unfortunately, under The Tax Cuts and Jobs Act of 2017 (TCJA), foreign real estate taxes on personal assets are no longer allowed as an itemized deduction on Schedule A.
  • You will also need to consider the currency gains or losses on the mortgage repayment. If the U.S. dollar strengthens, you may have a gain on the principal repayments, and a currency gain will be taxed as ordinary taxable income on your tax return. No loss is allowed if the property is used for personal use.  [i]

Can you write off improvements like you can in the states? Also, insurance? HOA fees?

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Rental Use

Titling of the property

  • Personal:
    • If purchasing the foreign property for rental purposes, will you own the property personally? If not, consider any issues of holding the rental through an entity.
  • Entity:
    • Using a foreign corporation to purchase a foreign rental property may likely result in double taxation and the loss of capital gains treatment upon the sale.
  • Partnership treatment
    • If the entity is eligible for a check the box election, the income or loss of the entity would pass through to the U.S. owner. Under this option, you should be able to retain one level of taxation and be eligible for capital gains treatment upon the sale. Be sure to include all necessary tax forms including but not limited to Form 8865 or Form 8858.

Other Considerations

  • Be sure to consider any local VAT on the rental income and any local income tax rate on the net rental income.
  • Similar to owning a U.S. rental property, the foreign rental property activity is subject to reporting on your U.S. income tax return. In addition, due to recent tax law updates effective for tax years beginning in 2018, a foreign rental property is now also likely considered a foreign branch subject to reporting on Form 8858.
  • Moreover, the foreign rental property will need to be reported on the BE-10 Survey every five years, which is administered by the Bureau of Economic Analysis (BEA). The most recent survey was conducted in 2019 and the next will be due in 2024.

[i] Currency gains or losses on sale:

As mentioned earlier, you will need to consider any currency gain or loss on mortgage principal repayment.

In the example below, taxpayer has a nondeductible loss on the sale of their home and a taxable ordinary gain on the principal portion of the mortgage repayment, worst possible option.

Example:

Clint Expat relocated to China in 2015, where he purchased his home on May 4, 2015 for 3,000,000 CNY with the USD exchange rate at .16 on this date. The home he bought in China does not qualify as his primary residence. His assignment to China ends in 2020 and he decides to sell the house. He sells the house on July 6, 2020 for 2,700,000 CNY with the USD exchange rate at .14. At the time he sells his home, he also has 1,000,000 CNY of mortgage he still has left to pay off.

Gain/Loss on Selling Home:

Transactions CNY Date Exchange Rate USD
Purchase Price ¥3,000,000.00 5/4/2015 0.16 $480,000.00
Sales Price ¥2,700,000.00 7/6/2020 0.14 $378,000.00
Gain/Loss on Property no tax benefit ¥-300,000.00     -$102,000.00

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Gain/Loss on Foreign Mortgage Exchange Rates:

Remaining Mortgage (CNY) ¥1,000,000.00
Purchase Date Exchange Rate 0.16
Mortgage Purchase (USD $160,000.00
Remaining Mortgage (CNY) ¥1,000,000.00
Sales Date Exchange Rate 0.14
Mortgage Payoff $140,000.00
Foreign Mortgage Gain/Los: ordinary taxable income $20,000.00

Upshot: home was not a rental – personal use only, no capital loss will be allowed on the loss from the sale; but the currency gain allocable to the principal payment will be ordinary taxable income with no offset from the loss on the home.

Whether you are transferred for work, on your way to becoming the next Hilton hotelier or just wanting to spend your summers in a Tuscan villa, buying foreign real estate is far more complex than buying a second home in Flagstaff. How you title it, how you use it and how you sell it has tax implications. Be sure to contact your Henry+Horne advisor and a licensed real estate agent to help you walk through all your options to minimize your tax liability in any eventuality.

Debra Callicutt, CPA, MBA, Partner, specializes in international tax consulting + compliance services for high net worth individuals and closely-held businesses. You can reach her at (480) 483-1170 or DebraC@hhcpa.com