One of the most common mistakes made by Americans overseas is the belief that they don’t have to pay taxes. This is particularly common given that very few countries tax money made abroad, leading Americans to believe the same rules apply to them.
This is untrue. Whether you are at home or abroad, you will owe taxes to both the IRS and a state or territory. Even real estate purchase overseas may have tax implications with Uncle Sam.
Wherever you live, buying and selling real estate can have tax implications. If you are an American, you will owe the same taxes on foreign real estate transactions as on domestic real estate. You will also need to correctly convert foreign currency transactions to U.S. dollars.
Here’s what you need to know.
Do you have questions about your overseas transactions? Match with a financial advisor to get answers.
U.S. Taxes Global Income
Many countries omit global income from their tax base. In layman’s terms, this means that those nationals don’t owe taxes when they make money abroad.
The United States is one of the few countries that do tax global income. This is known as citizenship taxation, meaning taxation based on your citizenship. Residence taxation, on the other hand, means taxation based on your location. Citizenship taxation often leads to Americans receiving inaccurate tax advice, as foreign nationals and even (sometimes) accountants give advice based on their own nations’ residency rules.
If, as an American, you make while overseas you will owe taxes on it. You will also owe taxes on any money you earn from overseas. This includes any applicable income or profits from real estate in foreign countries.
Talk to a financial advisor about the implications of your overseas activities.
U.S. Citizens Owe Taxes on Property Sales at Home and Abroad
Real estate sales are taxed as capital gains if you held the property for more than a year. They are taxed as income if you held it for less than 12 months. Profits from a property add to your taxable gains or income, while losses deduct from those gains or income.
Profit and loss are defined by the property’s underlying cost basis. This is defined as what you paid for the property, plus some applicable costs such as upgrades and renovations. You subtract the property’s cost basis from its sale price, and that gives your final applicable profit or loss.
This is true no matter where in the world your property is located. Whether you sell property in New York, London or Dubai, you will owe capital gains or income taxes depending on the profits.
You do receive a limited exemption for the sale of your primary residence. Individuals receive a $250,000 exemption while married couples receive a $500,000 exemption. You are not taxed on any profits within this exemption, and will owe taxes on any profits above that cap. This rule holds true if your primary residence is in a foreign country.
A financial advisor can help you figure out the best strategy for mitigating taxes.
Purchasing Property Overseas as an American
It is also common for foreign countries to restrict real estate ownership. This is particularly true in the case of commercial real estate such as rental properties. In these cases, Americans may purchase properties through real estate trusts or other holding companies that own the properties on behalf of the American.
If you own a property through one of these entities, or if you own a share in one, the same rules apply. When you sell your interests in the trust or corporation, you must report the profits as a capital gain or income.
U.S. Citizens Owe Taxes On Income
The same taxation rules apply if you own income-generating property overseas. This is most common for people who own rental properties.
When a property generates income, you will add this money to your taxable income for the year. You can also deduct applicable costs associated with the property, reducing taxable income.
This is true regardless of the location of this property. In general, the rules are identical whether you own income-generating properties in the U.S. or abroad. However, you will have to be aware of local laws regarding depreciation and other treatment of real estate taxes, as they may vary from U.S. standards.
In some cases, your taxes paid to a foreign government may help you qualify for a foreign tax credit in the U.S., reducing your taxable income or your tax liability. A financial advisor can help guide you through filing taxes with overseas activity.
Taxes Are Assessed in Dollars
Another discrepancy to account for is that American taxes are assessed in U.S. dollars. This is true regardless of the currency in which you received payment or the currency in which you hold money. This means that you must convert the value of sales and income into dollars for the purposes of your taxes.
For capital gains, make this conversion as of the date of each transaction or tax event. This means that you record the cost basis of any asset in dollars as of the date of the purchase, transaction or step-up event. You record any change to this cost basis in dollars as of the date of the improvement, transaction or step up event. And you calculate any profit or loss in dollars as of the date of the sale.
For example, say that John, an American, makes the following transactions:
- June 1, 2015 – Purchases a property in Athens, Greece for 50,000 euros
- October 7, 2018 – Upgrades the kitchen in his property for 5,000 euros
- February 1, 2023 – Sells the property for 80,000 euros
He would calculate his taxes as follows:
- June 1, 2015 – Conversion rate 1 Euro/1.09 USD = $54,939
- October 7, 2018 – Conversion rate 1 Euro/1.17 USD = $5,855
- February 1, 2023 – Conversion rate 1 Euro/1.08 USD = $86,783
The cost basis of John’s property is $60,794 ($54,939 + $5,855) and he sold it for $86,783. He will owe capital gains taxes on $25,989.
The same is true of income taxes. Workers who have an annual salary or wages may convert their annual pay as of when they pay their taxes. To do this, they will use the IRS’ average annual exchange rates.
Independent sources of income, such as that generated by privately owned real estate, must typically be calculated as of the time you received the payment. So, for example, if someone paid you 1,000 euros to rent your cottage for a week and you received that money on August 15, you would owe taxes based on the value of that payment in dollars on August 15. This can be difficult to keep track of, and you may need to back-calculate some payments if you did not convert them at the time, but it’s important to stay on top of.
Remember, a financial advisor can help guide you through overseas transactions and their corresponding tax requirement in the U.S.
Bottom Line
For Americans, the taxes you owe on foreign real estate are largely identical to the taxes you owe on domestically held properties, but there may be different laws in the country your property is in which you must follow. Remember is that you must calculate the value of any transaction in dollars as of each tax event to keep on top of your conversions. Additionally, you may be eligible for foreign tax credits in some cases depending on your overseas activity.
Foreign Investment Tips
- Investing abroad can be an adventure, and is frequently risky. But if you’re interested in opportunities outside of the United States, a foreign portfolio can have some very real opportunities and advantages.
- A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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