One of the more common issues that our clients face in their expat tax filings is determining the proper tax treatment of the sale of their personal residence abroad. The following are some of the key U.S. tax considerations when selling a foreign residence.
The Primary Residence Exclusion
When selling your residence, the first key issue to consider is the potential application of thex primary residence exclusion. Under this rule, an individual can exclude a gain of up to $250,000 realized from the sale of his or her home ($500,000 if married and filing jointly), provided they meet the “ownership test” and “use test.” This exclusion is not limited to homes in the U.S.
The Ownership Test – If you owned the home for at least 24 months (2 years) during the last 5 years leading up to the date of sale (date of the closing), you meet the ownership test.
The Use Test – If your home was your residence for at least 24 of the months you owned the home during the 5 years leading up to the date of sale, you meet the residence requirement. The 24 months of residence can fall anywhere within the 5- year period. It doesn’t even have to be a single block of time. All you need is a total of 24 months (730 days) of residence during the 5-year period.
If you do not fulfill the ownership and use tests, you still may be eligible for a partial exclusion if you can show the main reason you sold your home was because of a change in workplace location (even within the U.S.), for health reasons, or because of an unforeseeable event.
It is important to note that any exclusion afforded under U.S. tax law does not release you from your obligation file or pay tax in your foreign country of residence. You could still end up paying tax on the gains in your country of residence while excluding all the gains from U.S. tax under the primary residence exclusion rule.
In many cases, however, the opposite tax scenario unfolds. Meaning, a U.S. expat’s country of residence will exempt the entire consideration from the sale of a primary residence, whereas the U.S. will tax the sale amount above the primary residence exclusion. The current maximum tax rate on the gain from selling a personal residence (above the exclusion) is 20%, as long as you have held the property for at least a year.
Other Related Tax Provisions
Gain realized from the sale of a personal residence in excess of the exclusion amount is subject to U.S. tax and cannot be excluded under the foreign earned income exclusion. However, the gain can be reduced by using foreign tax credits.
Gain realized from the sale of a home and which is excluded under the primary residence rule, is not be subject to the 3.8% Obamacare tax.
Foreign Currency Exchange Issues
Consideration should also be given to the tax consequences associated with currency exchange differences if the residence was bought and/or sold using foreign currency as well as if there was a payoff of a mortgage denominated in a foreign currency.
These issues arise due to the fact that US expats are required to use the U.S. dollar as their “functional currency” for monetary transactions, including the purchase and sale of a foreign personal residence.