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What to Consider Before Buying Foreign Properties as a U.S. Expat?
Author: Joel Baretto, CFP®
October 31, 2023
Are you an expat looking to buy a home in another country? It is a difficult predicament to be in, especially when taxes are involved. Consider foreign exchange rates, mortgages unique to a country, tax regulations, and legal frameworks.
Moreover, if filing threshold is met, U.S. expats must report their global income. You may even have to include overseas property transaction data on your tax return!
This article will go over the most crucial aspects to consider when purchasing or selling property abroad as a U.S. expat.
1. Property Transactions are Handled Differently in Foreign Countries
Are you aware that real estate transactions differ significantly from those in the United States? This is why we recommend double-checking your house insurance and real estate legislation in your home country. You must ensure that purchasing property overseas as an expat is lawful and secure!
You can also create a bank account in your host nation to assist you manage overseas property taxes and mortgages. Due to FATCA (Foreign Account Tax Compliance Act), you’ll need to fill out certain documentation before you can create a bank account. Furthermore, you may be required to file a Foreign Bank Account Report (FBAR) each year.
As a U.S. expat, you’ll almost certainly need to make a down payment and transfer a considerable quantity of money to purchase property abroad. This may necessitate the filing of an FBAR or Form 8938 for your international bank accounts.
When it comes to living abroad, there may be considerable foreign exchange rates and costs to be mindful of. As a result, you may wish to engage a broker to assist you in saving as much money as possible during the purchase process.
2. Local Property Taxes and Laws Impact your Purchase
Before purchasing property as an expat in another country, check with your local U.S. embassy or expat community for information on local property taxes and legislation.
The legislation and international purchasing costs could change every year, so it’s critical to keep current. Purchasing costs may be greater than in the United States, so check with your local community for the most up-to-date information. Planning ahead of time and conducting thorough research might save you a lot of money in the long run.
It’s common practice in many nations to buy foreign property through a holding company rather than in your own name. If your local government offers alternative possibilities for the holding corporation, for example, we recommend that you speak to an expert before deciding. Some types of foreign businesses may make it difficult for you to qualify for gain exemptions, resulting in costly tax forms.
Your mortgage points and interest are still tax deductible in the United States, regardless of where your home is located. However, you must record this information on your tax return in US dollars. When claiming your deduction, you may use the IRS annual exchange conversion rate to convert your foreign currency into US dollars.
3. Foreign Exchange Rates Matter While Paying Mortgage
You will have profits or losses as a result of the foreign exchange rate you converted when paying off your mortgage while residing on a property overseas.
The IRS considers the use of currency exchange that resulted in a gain or loss (as a result of paying off the mortgage) to be personal. As a result, any losses are not deductible. However, any profit you make as a consequence of this can be taxed at ordinary income rates.
Keep in mind that if you lived in another country for at least a year, you may be eligible for lower long-term capital gain tax rates. Unfortunately, you can’t utilize losses from the sale of your house in another country to counterbalance currency exchange rate gains.
4. To Qualify for FEIE You Need to Have a Home Abroad
According to the IRS’s “tax home test”, US citizens or Green Card holders are ineligible for the Foreign Earned Income Exclusion (FEIE) unless their tax home, or adobe, is outside the United States. A residence, home, or dwelling area is referred to as an abode. The location of your residence is also determined by your economic and social relationships.
Furthermore, your “tax home” is usually defined as the location where you work, whether permanently or on a temporary basis. Furthermore, in order to qualify for the Foreign Earned Income Exclusion, your residence or house cannot be in the United States.
There are, however, certain limitations. You might, for instance, rent off your Brooklyn condo while working for Disney in Japan and yet be eligible for FEIE. Why? Because your tax residence is in another country.
What if the IRS questions me about my tax home?
If the IRS ever queries your use of the FEIE, you must demonstrate that you are truly living the expat life. Having foreign bank account records, mobile phone registration within the host nation, and registration documents from clubs you’re a member of are all examples of proof. The IRS uses the tax home test to ensure that foreigners are not breaking the FEIE.
5. You May Need to File the FBAR (Foreign Bank Account Report) while Transferring Funds
After you’ve signed the documents to buy a property, you’ll need to deposit your payments to the seller. Typically, expats will transfer funds from a US bank account to a foreign bank account and then transmit the funds to the seller.
U.S. expats will almost certainly have more than $10,000 in their foreign bank account as a result of this procedure. The FBAR obligation is triggered when or if this occurs. The FBAR is a required filing for Americans living abroad who have an aggregate balance of more than $10,000 at any point in the year. If you do not wish to submit the FBAR, you can transfer payments straight from your US bank account to the seller’s account.
6. Hold onto Property Documents for Future Tax Purposes
You won’t be earning any money by buying a residence in another country; therefore, it won’t trigger anything for the IRS. This implies that the first year you purchase a property as a U.S. expat, you don’t have to disclose anything to the IRS.
However, keep records because selling a property overseas is a different process. You’ll need to keep track of the money you made from the house and property, as well as the costs of upgrades and other expenses.
7. Can you claim Foreign Property Taxes on U.S. Tax Return?
You cannot claim personal or real property taxes as an itemized deduction when purchasing real estate in another country as your primary or secondary residence.
Unfortunately, as previously stated, you cannot deduct foreign mortgage interest on your US tax return. But, if you rent out your overseas property, you can deduct foreign property taxes as an expense.
8. There are Different Rules for Expats Buying Property to Rent Out
If you purchase property in another country as an expat to rent out, you will be liable to a distinct set of tax requirements. Rental income must be reported on Form 1040 Schedule E of your US tax return. You cannot deduct mortgage interest from this; however, you may deduct property taxes, renovations, maintenance, utilities, insurance, management costs, and depreciation.
When it comes to international property, depreciation must be estimated over 30 or 40 years, based on when the property was first rented out. The 27.5-year depreciation schedule that most US tenants are accustomed to is not applicable to foreign rental properties. Depreciation is the gradual loss of an asset’s value over time due to wear and tear.
Finally, if you pay tax on your international property rental income, you can claim the Foreign Tax Credit (FTC). This is a dollar-for-dollar decrease on your US taxes that is applied to your foreign earned income.
Disclaimer:
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