EP 15: All I Want is a Room Somewhere! Owning Property Overseas
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Owning foreign or overseas rentals is very attractive, especially for foreign-born individuals with strong ties to their "home" country.
The question has also frequently come up with foreign nationals on work visas who are not going to be in the U.S. for the long term and want to start building passive income overseas. Given the current situation in the U.S., we can appreciate the attractiveness of the proportion.
There are different areas to cover, but in today's episode, we will answer the top five questions we see repeatedly. In the future, we'll tackle more questions.
Also, if your top question is not addressed, please send it to us, and we'll add it to a future episode.
Today's questions are:-
How do you determine the value of the overases property?
Are you required to report it to the IRS (your U.S. taxes), and if so, how?
What forms do you need to report rental income?
Can you convert a primary resident to a rental property and vice versa, and if so, does the section 121 exclusion apply?
What about the exit plan? What are the financial, tax, wealth, and cultural implications of the decision?
The speakers' views and opinions discussed in this episode should not be considered financial, tax, or legal advice. Consult your advisor for any legal, cross-border tax, and financial advice.
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Speaker 1 (00:06):
Welcome to the International Money Cafe podcast, the show where we filter out the noise on cross-border taxes, finances, and life in the us. I'm your host, Jen Hams, certified financial planner, founder and owner of Elgon Financial Advisors.
Speaker 2 (00:21):
And I'm your host, man, Nadi, enrolled agent, owner and founder of Amman Tax and Business Services. Join us on this journey as we explore the unique challenges faced by inbound outbound families and businesses on taxes, compliance and financial planning. Let's get to the show.
Five Questions on Real Estate Ownership
Speaker 1 (00:43):
Today's topic was triggered by a very interesting conversation Manas and I had last week. One of our clients is interested in investing overseas and it actually got us talking about how recently we seem to be getting a lot of questions from us persons wanting to invest in real estate outside the country. So this is either in their home country or another country that's not the US or their home country. And as we all know, real estate has been and is a very popular wealth building tool in seeing what's happening with the US housing. With the prices going up, it kind of makes sense that people want to look outside. So in today's episode, we're going to answer five questions that we've seen on real estate ownership. There are a lot of areas we may or may not cover. It just depends on the questions that we answer.
Speaker 1 (01:50):
And the other thing I do want to point out is this is people investing in real estate or they may have inherited or this real estate was gifted to them. So we are going to address US citizens, naturalized, all born in the US permanent legal residents. So this is folks on green card as well as foreign nationals on work visas based in the US because remember, all these rules apply to you being considered a US person. It all comes down to how you file taxes. So let's see. Mana, we got five questions. Which one do you want to tackle first?
How to Determine the Value of Property
Speaker 2 (02:37):
Alright, Jane, nice setup there to lead us in. And yes, if you are one of these people that we just talked about, and if this does apply to you, we've seen that the big question for you is yet now I've decided that I have this rental property abroad and or I am going to get a rental property abroad. How do I determine the value of this property? And that always starts off this discussion with how did you acquire this property? If this property was purchased by you, then obviously the value of this property is the cost of it. Plus whatever expenses you had in acquiring the property, as well as maybe having to set it up as a rental. What did you have to do to the property? Maybe you had to add in more cupboards, let's say, so that you could rent it out.
Speaker 2 (03:43):
So all of those expenses, right? So if you purchased it, that's what it would be. The cost of the property in good plus all of the expenses like closing costs and other things, plus all of the capital expenditures to set it up as a rental property. That is where you would start off as. Now let's say you were lucky enough to have inherited a property from your family and it is situated abroad. Now, the fact that it is situated abroad will not affect the way that this property is valued in the eyes of the IRS. So we are going to get the same treatment that you would if it was in the US as far as determining the value of this property, which is you would get a step up in basis. And what does that mean really quickly is that the person who owned this property before they died, the value of the property to them who would've been different, but now that you inherited it, the value of it to you is the valuation of that property on the date of death of the person from whom you inherited this.
Step Up in Basis
Speaker 2 (05:06):
So that is what's called a step up in basis. So that would determine the valuation of this property if it was inherited. Now let's say again, you are a lucky person. Let's just go with that. And this property was gifted to you. So what happens with a gift is that does not change the cost of the property. That was to the gift tour. It remains the same as what it is to you. So whatever was the cost of the property to the gift tour is going to be the cost of property to you and that's how you're going to value this property. Let me mention this really quickly here is that you may have other reporting requirements if this was an inheritance or a gift from a non-US citizen, and we can talk about that a little more later. Let's come back to the valuation of the property. So you have a purchase or you have an inheritance or you have a gift and either one of these situations determines how you're going to value the property. And then this also includes land or commercial property or residential property. And all of these fall into this purview. So do you think that was a good question to start with, Jane?
If I Own a Rental Property Overseas, Do I Have to Report it in my U.S. Taxes?
Speaker 1 (06:33):
Yeah, so I think it really is and it's great. Now it's like, okay, I have this property, now I know what it's worth. So let me jump to the next one, which is, and I see this one all the time. If I own rental property overseas, do I have to report it in my US taxes? And the answer is yes, you do. So remember, the US taxes you on worldwide income, which means it doesn't matter where this property is, you could have a nice place on the moon. The US is still very, very interested in knowing what kind of income you are getting from that. And so you do need to include your rental income, I believe on Schedule E, you are able to deduct expenses, things like management fees, let's say repairs, travel to go see the property. Maintenance can also be deducted, mortgage interest, property taxes, insurance.
Speaker 1 (07:37):
So pretty much everything that you need to run this property. And this is now assuming you're using it as a rental property, you are also able to do your regular depreciation if it has what IRS calls determinable useful life and is expected to last more than a year. Now the depreciation obviously does not include the value of land. And in terms of when you are reporting this, because most likely or not most likely this is going to be in a foreign currency, you need to convert that foreign currency into US dollars and you can use the average exchange rate or in some cases I've seen where you use I think the year end rate. But I think the key thing to know is you do need to do the conversion. So you are reporting it in US dollars and because I'm thinking about that manasa, why don't I pass it back to you to do the next question, which I'm sure has something to do with taxes.
What forms do I need to Report Rental Income on my Taxes?
Speaker 2 (08:41):
Yes, Jane. So just picking up where you left off because yes, we have now determined that this has to be declared on your US tax return. So the next question obviously is, well, maybe not obviously, but the next question is what forms do I need to report this rental income? And this can get pretty extensive. So one you already addressed schedule E, and so I won't go into that. And the other forms that you might need is, remember now you have a property abroad and you are collecting rent. So where is that money sitting? So if this money is being deposited into a foreign bank account, then we have the F bar and the FATCA forms depending on what the threshold is in these bank accounts and what the exchange rate is that you already talked about, right? So we have the schedule E, we have the F bar and the FATCA forms, and then if this rental is considered a trade or business, and typically that happens if you have more than one rental property in that country, and it could be that it is considered a trade or a business.
Speaker 2 (10:08):
And if it is, then that rental needs to be reported on a form 8, 8, 5, 8. Now the 88 58 asks a little more information about the foreign rental and all of that on top of the schedule. So you have to send that in with your individual tax return. Now we talk about the income which you already addressed, income minus expenses, minus depreciation. You might still have some income left over and this income is now subject to US taxation. Now, let's say you are filing taxes for the same rental income in the country where the property is situated, and therefore now what you have is a foreign tax credit which is available to you. So if you do have this, then you need yet another form, which is the 1116, the 1 1 1 6, so that you can tell the IRS, Hey, I'm paying for taxes on the same income in that other country and I can claim that as a credit on my US return.
Speaker 2 (11:21):
So we've got your schedule leave, we've got your fpar and fatca, and then we've got your foreign tax credit form 1, 1, 1 6. Now a little more complexity added to this, which is why we love complexity. So if you've decided that this rental is now owned by a foreign entity, which means that this rental property is not directly owned by you but is now housed within either a foreign corporation, a foreign partnership, or maybe even a foreign trust, and maybe it's a practical decision in the country where the properties is located, that the should be how it is. But what happens is that now if you are a majority holder, which is about 10% for a foreign corporation and partnership of this entity where the property is housed in, then there are additional international information forms that apply. And of course, if it is within a foreign trust, then we have to look at whether that's a grantor trust and a non grantor trust.
Speaker 2 (12:40):
And we don't have to go into that today. But what that really means is now your foreign rental has added on all of these additional filing requirements and most often they're not. When you are at this stage, then you should be working with a, definitely working with an accountant in the country where the property is. And we may also be looking at working with an attorney in that country and sort of also have a US tax attorney look at it and make sure that all the T's are crossed and the is are dotted and things like that. So heads up, it may end up even after all of these things and the foreign tax credit, et cetera, that you may still end up owing taxes to the IRS on whatever residual income and taxes that came out after making all these calculations. So a simple question, what forms do I need to report with the rental income? But there's a lot that goes into that, right, Jane?
Speaker 1 (13:55):
Yeah, and I think after hearing about all these forms in the taxes, I'm going to enjoy answering the next one, which is can I convert my primary residence to a rental property or vice versa? In this case, it really comes out to can I convert my overseas rental property to a primary residence? And you are allowed just like in the US to convert your rental property into a primary residence. It of course means you are now living overseas. In that case, as long as the local rules and regulations apply, and as long as all the residency rules are met, you will be able to still use the same, let's say, section 1 21 exclusion when you get around to selling it. But the thing I do want to point out is these really applies to US citizens and green cut holders because if you are a foreign national on a work visa, you own rental property, you move back home, you are pretty much done with the US taxes access at that point. So yeah, so this is only for green cut holders and US residents. And I think that's all I want to say on this. So why don't I get it back to you for the next question.
What are the Tax Implications of my Exit Plan from Rental Property?
Speaker 2 (15:20):
All right, thank you, Jane. Yes, after having talked about all of these, the next question that we get rather and we would like to address is what are the financial and tax and the wealth tax implications of my exit plan from this rental property? That is, what do I do with this rental property if I decide that A, I don't want it anymore or can I transfer this to someone else in the family? So that is something that is a plan that you need to put into place very, very carefully. And it doesn't matter. It could be a small property worth not much, or it could be a property worth millions, but you need to have a plan. So again, let's say you decided that you wanted to sell this property. So obviously when you sell an investment, you have capital gains and the length of the time that you have held onto this investment determines whether those gains are going to be short-term or long-term.
Speaker 2 (16:39):
In the US, short-term gains are investments that you held for a year or less, and long-term gains are investments that you held for maybe a year plus one day. Let's just say that. So now this investment property that you have sold is subject to capital gains tax on your US tax return. And one thing that I have found interesting, Jane, is not all countries adhere to the same length of time to determine whether they are short-term or long-term gains, right? Some of the countries, and India comes to me in particular, is that they want you to hold an investment for three years for it to be considered long-term and for you to have a favorable tax rate on that. And there are other countries, again, which have different holding periods to determine long-term or short term. So you need to take that into consideration in your plan when you make this exit plan.
Speaker 2 (17:42):
And of course, we have already spoken about double taxation of the rental income. There is some aspect of it when you sell the property as well. The same thing when you're looking at capital gains. Are you going to be filing taxes in the other country and are you going to be paying taxes there? And then if you are, then what's the timing aspect of that and how are you going to be able to claim that as a credit on the gains that you may now have on your US return? So yes, so there will be the sale and there's the capital gains. So you really need to be looking at the holding periods and also depending on where the property is located, again, which country, there are these additional debt and estate tax considerations, and each country is so different with the way that they tax properties if the holder dies and how that transfers over to someone else.
Speaker 2 (18:46):
So you need to take that into consideration when you're making a long-term plan. And the same thing applies really if you want to just hold on to this and then maybe pass it on to the next generation or even the generation after that. And then you really need to be looking at the valuation of the property. And right now it's a healthy 13 point some million dollars in estate exclusions in the US at least. But you need to take into consideration what that situation will be if you are a US citizen or a green card holder and how does that country, where the property is located, look at it, and how are they going to tax you if you just transferred it, whether there's a gift tax involved and so on.
What Should My Exit Plan Be?
So that's a question I get about, oh, what should my exit plan be? Or sometimes I feel like that's the question I should get about what should my exit plan be when somebody is looking at purchasing a rental property or an investment property abroad?
Speaker 1 (20:01):
Yeah, I love it. So
Speaker 2 (20:02):
That's what I have, Jade.
Speaker 1 (20:04):
I love it. But one thing I'm going to add to this, you've talked about the tax and financial considerations of your exit plan. The thing I do want to add is there's a lot of cultural considerations when it comes to property abroad. So if I own a piece of property, let's say, and my family considers this to be ancestral land or it's a property that was gifted to me by let's say my parents and they wanted to stay in the family, I just can't sell it. And the assumption is that I'm going to be giving it to my kids. What I'm seeing a lot of happen, and you and I are in this same exact situation, is we came to the US as adults. So we already know the values, the cultural values, expectations of owning property in our home countries, but our kids who were born in the US may not have that attachment, that sentimental value of some of these properties.
Speaker 1 (21:13):
And so what we now see to folks who are in our situation, you grew up in another country, your kids were born in the US, is please start having these discussions with your kids as soon as possible. Let them understand what owning property, especially family property means in the home country or in the country that you came from, and let them understand that when it comes to selling it or keeping it these more than just the financial and tax considerations, they do need to take into consideration the cultural values. If there's sentimental value, they do need to add all that into the decision. It does make it a little bit more complex, but I also think it makes life a little bit more interesting. And so with that, man, I'm going to pass it back to you to conclude.
Speaker 2 (22:10):
Yes, thank you, Jane. So you know what, my biggest takeaway from this discussion today would be investing in a rental property abroad if I haven't already done so, or if I'm not inheriting or I'm getting a gift of it, is these are considerations that you should seriously think about. And definitely like we always say, work with professionals on both sides of the border as far even if it comes to wills and stuff like that. And today we've covered this topic at a high level, and if you have more questions, dear I am cafe listeners, please reach back out to us and let us know. We would love to come back and address more of your questions on future episodes, be it about real estate or other things. Yeah, and if you would like to do that, please go to our website, the i am cafe.com, again, the I am cafe.com. And the easiest way to do this is just scroll down on the page and where it says to subscribe to our newsletter, send us your email. We love to hear from you, and we'll get back to you. And also bonus, you'll be notified before anyone else when our podcast drops. So we look forward to hearing from you and we'll keep bringing you more and more such great episodes. Thanks for listening. Bye bye.
Speaker 3 (23:42):
Thank you for listening to the International Money Cafe podcast. The content is for informational and educational purposes only, and should not be used as a substitute for professional advice. Seek the advice of your qualified service provider with any questions you may have regarding your cross order finances and tax needs.