I keep saying this, “The world is shrinking!”, ad nauseum perhaps, but I just cannot seem to get over that. When I went into the tax profession 15 years ago, I never thought I’d be reading as many tax treaties as I do now! I found out that the US had a Tax Treaty with Ukraine this year! Go figure!
Speaking of a shrinking globe, Inter-Governmental Agreements and Tax Treaties, it was uncanny this tax season, I had more than my share of clients who had a property or two in foreign countries by way of an inheritance or purchase and after having held it for a while as investments, they were now contemplating turning them into rentals.
I had written about owning foreign real estate a few blog-posts ago. You can read more on it here. Today we are going to focus on tax reporting of foreign rental properties. Foreign rental properties owned by US citizens are treated the same way as domestic rental properties.
The following points however, need to be kept in mind:
Determine Value Of Property:
If the property has been passed on to you via an inheritance, there could be a “step-up” in basis. Essentially this means, no matter when the property was purchased by the original owner, the cost/ basis of the property is determined as of the date of death of the original owner.
If the property has been purchased by you, you have to determine the value of the property based on its current market value.
In either case, having an appraisal from a competent, licensed real estate professional is good record keeping. Many times, based on where the property is located, the appraisal may have to be translated into English.
The Internal Revenue Service has no official exchange rate. Generally, it accepts any posted exchange rate that is used consistently. When valuing currency of a foreign country that uses multiple exchange rates, use the rate that applies to your specific facts and circumstances.
For instance, if you have a single transaction such as the sale of an investment that occurred on a single day, use the exchange rate for that day. However, if you receive income evenly throughout the tax year, you may translate the foreign currency to U.S. dollars using the yearly average currency exchange rate for the tax year.
The yearly average currency exchange rates are posted by the IRS here.
A property that you own and rent out, if it has a determinable useful life and is expected to last more than a year has to be depreciated. The value of land cannot be included in the depreciable value.
You begin to depreciate your rental property when you place it in service for the production of income. You stop depreciating it either when you have fully recovered your cost or other basis, or when you retire it from service, whichever happens first.
Under IRC Section 168(g)(1)(A), a foreign rental property has to be depreciated using the ADS over 40 years.
All rental income and expenses are reported on Schedule E or Schedule C to your Form 1040. If you pay taxes on this income in the foreign country, they can be deducted as foreign taxes paid. See my post regarding foreign tax credit here.
Just as rental income above, rental expenses such as mortgage interest paid, property taxes, insurance, payments to property management companies, repairs, travel, and certain other expenses towards maintenance of the property can be deducted on Schedule E or Schedule C as well.
If the rental income results in your foreign bank accounts balances to fall under the FBAR Compliance requirement, then you have to file Form 8938 and/ or FinCEN Form 114, if the thresholds are met.
More on the FBAR Compliance requirements in my post here.
Limits On Rental Losses:
If your expenses are more than your rental income, you will obviously have a rental loss. However, you may be limited from claiming all your rental losses in the year of occurrence.
The 2 sets of rules that may limit you from claiming the loss are either “At-risk rules” or “Passive Activity Limits”. There may be certain exceptions to this.
If all of the above were to apply to you, that is you have rental property in a foreign country, please remember that this blog-post touches only on the main points. There are a many other nuances and complexities to owning rental property whether it is domestic or foreign. Please consult an Enrolled Agent if you are in such a situation.
Original Post By: Manasa Nadig