Can Overseas Property Alleviate Your U.S. Tax Burden?
Americans are at a disadvantage when it comes to taxes… I don’t think I need to elaborate too much on that point.
Only two countries in the world operate citizenship-based taxation systems rather than residence-based ones: the United States and Eritrea, a tiny country in northeast Africa.
As an American abroad, no matter where in the world you move, you’ll still have to file a tax return with the IRS every year, even if it’s just to tell them you don’t owe any money.
But while you’ll always owe something… you should never pay a single penny more in taxes than you’re required to. Certain offshore strategies can help you legally lower your taxes.
This, plus creating, managing, and protecting wealth through international diversification, is the focus of Lief Simon’s Offshore Wealth Summit, taking place Sept. 20–22 in Panama City, Panama.
For today, I want to talk about how overseas property can be part of your offshore strategy, specifically when it comes to your U.S. tax burden.
5 Tax Benefits Of Overseas Property For Americans
1. Hide Your Money In Plain Sight.
There are only a handful of assets that Americans don’t have to declare on their tax filings:
- Property outside of the United States (held in your personal name),
- Physical precious metals (with some exceptions), and
- Collectibles (art, antiques, jewelry, rare vehicles).
These can all be major stores of wealth… but the asset class I’m most interested in is overseas property.
I see it as a sure way to improve your lifestyle almost immediately: It makes travel and adventure part of your life, it can provide free vacations in interesting and low-cost locations, and it can generate income and capital appreciation…
The IRS says, “Foreign real estate is not a specified foreign financial asset required to be reported on Form 8938. For example, a personal residence or a rental property does not have to be reported.”
It likely leaves foreign real estate alone because, even if it wanted to, it’d be unable to seize or force the sale of your second home in Belize, your penthouse in Colombia, your beach house in Brazil, etc. Neither would a lawyer, former spouse, or ex-employee.
2. Exclusions And Deductions.
If you invest in overseas rental property, it’ll be treated more or less the same as U.S. rental property for U.S. tax purposes. You report the rental income on a Schedule E, as you would for U.S. rental income.
You’re allowed the same expense deductions, plus you can deduct the cost of every trip you take to check on your property on your U.S. tax return. This is a benefit of buying investment property in places where you enjoy spending time.
It’s also possible to deduct the interest paid on your mortgage for your foreign home from your taxable income. Note that depreciation is treated differently: It’s calculated on a 40-year schedule for foreign properties.
If you’re a U.S. expat earning overseas, the Foreign Housing Exclusion (FHE) allows you to exclude thousands in foreign housing expenses from your U.S. taxes.
For the 2022 tax year (filed this year), the standard housing exclusion is US$15,680 (14% of the Foreign Earned Income Exclusion (FEIE)). However, you could exclude a much larger amount, depending on where you live.
The IRS issues an annual notice identifying countries and locations within those countries where housing costs are high relative to those in the States—allowing for a larger exclusion.
The FHE can include rent, housing provided in kind by an employer, utilities, insurance, occupancy taxes, household repairs, residential parking, and more.
3. Foreign Tax Credit.
A foreign tax credit (FTC) can reduce the amount of U.S. income tax payable by any foreign tax paid on your entire income (not just earned income). It also reduces double taxation.
FTC works for all earned income, not personal earned income. Foreign earned interest, dividends, rent, capital gains, etc. are all income.
You can’t claim FEIE and FTC on the same income, but in specific circumstances, you can claim some of the excess over the FEIE through FTC.
4. 1031 Like-Kind Exchange.
Another tax benefit of overseas property is the 1031 like-kind exchange, a kind of tax loophole that lets you defer tax on your gains by reinvesting the proceeds from the sale of one property into the purchase of another (following specific rules).
For this loophole to work, you need to have sold foreign property and be reinvesting it in foreign property. (You can’t sell U.S. property and use it to buy foreign property, for instance.)
Also, it has to make sense from an investment perspective, which it can if the country where you’re selling property does not charge capital gains tax.
If you’re selling property in a country that does charge capital gains tax, it’s probably more advantageous to take the credit for the taxes paid in the other country.
5. Access To Low-Tax Jurisdictions.
If you’re willing to relocate overseas, you can optimize your tax situation by buying property in a country that offers residency-by-investment and is also a low-tax jurisdiction.
Panama and Belize are two of the top choices for this. Both countries tax jurisdictionally, which means that they only tax you on income earned in that country, even as a resident.
By relocating to a low-tax jurisdiction, it can be possible to organize your affairs in a way that can reduce or even eliminate your tax burden.
2 Tax Disadvantages Of Overseas Property For Americans
1. FATCA And FBAR.
You may need a local bank account in the place where you’ve invested in property to pay local bills or deposit money.
First, you may find it difficult to find a foreign bank that’s willing to take you on as a client because of the Foreign Account Tax Compliance Act (FATCA). FATCA requires banks around the world to disclose account information for American clients with US$50,000 or more in their accounts to the IRS.
The global banking industry has to comply with FATCA if it wants to do business in the United States… Banks have either figured out how to do this or have dropped all their American clients.
Today, fewer international banks will take on American clients. For those that do, there are higher fees to cover FATCA-associated overheads.
If you manage to open a foreign bank account, you’ll have to file a Foreign Bank and Financial Accounts (FBAR) form if you hold US$10,000 in your account (or across multiple accounts) at any time.
Failure to report can mean big penalties. A willful failure to report carries a US$100,000 fine, while a non-willful failure carries a US$10,000 fine.
2. Local Tax Liabilities.
Owning property in another country can trigger local tax liabilities—both when you buy and when you sell, as well as ongoing taxes.
Here’s a rundown of the top property-related taxes you need to consider…
- Property tax. Generally speaking, property taxes are lower overseas than they are in the States. In fact, some countries don’t even charge them.
- Property transfer tax (also called stamp duty). This can be more significant. In many countries, the buyer pays a government transfer tax that can range from 1% to 10%.
- Taxes on rental income. Many countries treat this as regular income for tax purposes, and you’ll need to file a tax return in that country to show the tax owed. In some cases, taxation on rental income can be more complicated than this. Spain, for instance, makes the presumption that any nonprimary residence is a rental and charges you tax on a presumed rental value for your property… Not ideal if you have a holiday home in Spain that you allow to sit empty.
- Capital gains tax. This is another cost to understand before you buy in any market. Not all countries charge capital gains tax on real estate profits. As an American, you owe capital gains taxes in the States even if no capital gains tax is charged in the foreign country.
- Other potential tax liabilities… like registration fees (usually less than 0.5% of the purchase price). These can be particular to specific markets.
This does not mean that, as a U.S. person living or investing overseas, you’ll owe tax in two countries…
Double taxation treaties almost always eliminate the possibility that both your new country of residency and your home country will demand a tax from you on the same income.
Editor, Overseas Property Alert