Getting U.S. Tax Deductions on Foreign Real Estate

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Getting U.S. Tax Deductions on Foreign Real Estate

More and more Americans are seeking abroad for holiday houses, rental income properties, and someplace to settle down after retirement, whether it’s in two or twenty years. With a few exceptions, the tax advantages of owning property overseas are comparable to those of owning in the United States.

Key Takeaways

  • The tax treatment of residences is the same whether the property is in the United States or abroad.
  • Mortgage interest, mortgage points, and private mortgage interest (PMI) are normally deductible on secured mortgage debt up to $750,000 ($375,000 if married filing separately).
  • When completing your tax return, you must itemize your deductions on Schedule A.
  • If you earn rental income, the regulations vary depending on how many days you utilize your house for personal vs rental purposes.
  • Foreign real estate taxes are no longer deductible on your US tax return under the Tax Cuts and Jobs Act (TCJA).

The advantages you obtain under US tax rules are determined by how you utilize your foreign property. For example, if you reside in the property, you may normally claim the mortgage interest deduction and deduct mortgage points and private mortgage insurance (PMI). If you obtain rental revenue from the property, you may deduct “ordinary and necessary costs for managing, preserving, and maintaining” it. These expenditures include mortgage interest, property and liability insurance, repair and maintenance, and local and long-distance travel linked to property upkeep.

Property for Personal Use

If you use the property as a second home rather than as a rental, you may deduct mortgage interest, mortgage discount points, and PMI in the same way as you would for a second home in the United States.

For 2022, you may deduct interest paid on the first $750,000 ($375,000 if married filing separately) of eligible mortgage debt on your first and second houses (total amount). It should be noted that if you purchased your properties before December 16, 2017, you are still eligible for the old deduction maximum of $1 million of qualifying mortgage debt. Check with a tax professional to see where you fall.

You may deduct interest on the first $750,000 ($375,000 if married and filing separately) of mortgage debt on a first or second property under the Tax Cuts and Jobs Act (TCJA). After 2025, the current restriction will return to the former $1 million maximum.

You can’t deduct expenditures like electricity, maintenance, or insurance unless you qualify for the home office deduction (available only if you’re not deemed an employee).

While the mortgage interest deduction is the same whether the residence is in the United States or overseas, property taxes are handled differently. Foreign property taxes are not deductible under the Tax Cuts and Jobs Act (TCJA) for tax years 2018 through 2025.

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Foreign Rental Property

If you get rental income from the property, the tax requirements become more difficult. Depending on how many days you use the residence for personal rather than rental purposes, different requirements apply. You’ll often fall into one of two categories:

  1. Personal residence: You rent out the house for 14 days or less and then utilize it for more than 14 days or 10% of the total days leased, whichever is larger. You may rent out your home to someone else for up to two weeks (14 nights) every year without having to declare the revenue to the IRS (IRS).Even if you rent it out for $5,000 a night, as long as you don’t rent it for more than 14 days, you don’t have to record the rental revenue. Because the property is classified as a personal residence, you may deduct mortgage interest under the regular second-home rules. You cannot, however, deduct rental losses or expenditures.
  2. Rental property: You rent out your house for more than 14 days and use it for less than 14 days, or 10% of the total days leased, whichever is larger. In this instance, the IRS considers the residence to be a rental property and the rental operations to be a business. All rental revenue must be reported to the IRS. However, the good news is that you may deduct rental expenditures including mortgage interest, advertising costs, insurance payments, utilities, and property management fees. The expenditures must be allocated between rental and personal usage depending on the number of days the residence was utilized for each purpose.

Remember that if a member of your family (e.g., your spouse, siblings, parents, grandparents, children, and grandkids) uses the residence, it counts as a personal day unless you get a reasonable rental charge.

Foreign properties are depreciated over a 30-year period, rather than the normal 27.5 years for domestic residential assets. In either situation, you may only depreciate the building’s worth; the land is not depreciable.

Capital Gains on Foreign Home Sales

If you sell your overseas house, the tax treatment is the same as if you sold a residence in the United States. It counts as your main home if you have lived in and owned it for at least two of the past five years. You may exclude up to $250,000 in capital gains from the sale (or up to $500,000 for married taxpayers). This exception does not apply if the house was not your main residence; in that instance, you must pay capital gains tax on the whole gain.

Keep in mind that the gain qualifies as a source of foreign income and so qualifies for the international tax credit. However, since it would not be deemed foreign earned income, you will be unable to claim the foreign earned income exclusion.

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1031 Exchanges

If you sell your overseas property, you may be eligible to use a 1031 exchange (also known as a like-kind exchange) to exchange one investment property for another “like-kind” property on a tax-deferred basis. Many investors use this approach to postpone the payment of capital gains and depreciation recapture taxes.

However, the tax classification of domestic property vs. international property differs significantly in that property in the United States is not deemed like-kind to any property elsewhere. Section 1031 of the Internal Revenue Code of the United States permits only domestic-for-domestic and foreign-for-foreign exchanges.

Section 1031 of the Internal Revenue Code of the United States permits you to sell and replace a foreign property only with another foreign property.

The United States deems any property outside the United States to be like-kind with any other comparable property outside the United States. So, you may 1031 swap one home in Panama for another in Panama—or in Ecuador or Costa Rica, for that matter. It simply will not be regarded comparable to any US property.

Tax Reporting for Foreign Property

You should be aware that depending on your specific circumstances as a foreign property owner, you may be needed to submit a variety of US tax forms. For example, if you rent out your property in another country and create a bank account to collect rent, you must submit a Report of Overseas Bank and Financial Accounts (FBAR) form if the total value of all your foreign accounts exceeds $10,000 “at any point during the calendar year.”

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations (if your property is held in a foreign corporation); and Form 8858, Information Return of U.S. Persons with Respect to Foreign Disregarded Entities and Foreign Branches (if your property is held in a foreign corporation) (if your offshore property is held in a foreign limited liability company).

Double Taxation

If you rent out your house in another nation, you may owe taxes in the country where the property is situated. To avoid double taxation, you may claim a tax credit on your US tax return for any taxes paid to the foreign nation on net rental income. There is, however, a maximum permissible tax credit. You cannot claim a credit for more than your US tax on rental revenue after expenditures are deducted.

You may claim a foreign tax credit in addition to a tax credit for any rental income taxes paid if you sell the property and pay capital gains tax in the foreign jurisdiction.

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Can I deduct mortgage interest on a foreign property?

Yes. The same requirements apply whether the residence is in the United States or overseas. Mortgage interest on the first $750,000 ($375,000 if married filing separately) of mortgage debt on your first or second property is deductible. The debt must be used to purchase, construct, or significantly enhance a house, and the home must be used to secure the loan. You must itemize on Schedule A Form 1040 or 1040-SR to claim the deduction; you cannot take the deduction if you use the standard deduction.

Can I deduct foreign property taxes?

Foreign property taxes are not deductible on U.S. income tax returns for tax years 2018 through 2025 under the Tax Cuts and Jobs Act (TCJA).

Will I owe capital gains on the sale of foreign property?

Maybe. The regulations are the same whether the property is in the United States or overseas. If you lived in and owned your house for at least two of the preceding five years, you may deduct up to $250,000 in capital gains ($500,000 if married filing jointly). Gains in excess of such criteria are taxed at either the short-term or long-term capital gains tax rates, depending on how long you held the residence. In general, if you excluded profits from another house sale during the past two years, you are not eligible for the exclusion.

Is foreign property depreciable?

Yes. If your property is classified as a rental, you may depreciate it on your tax returns. Unlike in the United States, where property depreciates over 27.5 years, overseas residential property depreciates over 30 years. Only the value of structures may be depreciated; land is never depreciable since it is never “used up.”

The Bottom Line

When buying overseas, take additional attention with the planning and details. Many nations have laws governing who may possess property and how it can be utilized. Homebuyers in the United States gain ownership to the property; this difference is not as evident in other nations. So, if you purchase a house in another country, be certain that the transaction is carried out in a way that safeguards your property rights.

Because foreign property ownership and tax rules are difficult and change often, consult with an experienced tax accountant and/or real estate attorney both in the United States and overseas to protect yourself.

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