“Coming Into U.S. Tax Compliance Book” – Chapter 8
John Richardson – CitizenshipSolutions.ca
For chapters 1 – 7 see here.
Prologue:
If (U.S. Person) then (Mr. #FBAR Ms. #PFIC and Uncle #FATCA) = Few investment and financial planning opportunities).
Yes, it’s true. There are only three things that Americans abroad can “invest in” that don’t trigger punitive taxation and/or expensive and complicated reporting requirements. They are:
1. Interest (as long as it is NOT from a money market fund – think PFIC)
2. Dividends from individual shares of stocks (NOT mutual funds – think PFIC)
3. Real Estate (as long as the real estate is not owned through a foreign corporation)
Let’s talk real estate and Americans abroad
Even Americans abroad are allowed to own real estate in their country of residence. That said, the taxation of their real estate is subject to exactly the same rules that apply to Homeland Americans. As always, this has the potential to create very serious problems for Americans abroad. I am going to divide this post into five parts. Each part will alert you to a possible “issue”. The primary purpose of this post is to alert you to possible “issues”. As always, I urge you to seek competent advice.
Remember that ALL transactions in “local currency” must be converted to the U.S. dollar equivalent at the time of the transaction. This can create enormous problems as described in “issue 3” below.
Five issues that concern Americans abroad and non-U.S. real estate
Issue 1: Americans abroad and the ownership of their principal residence
People have to live somewhere. So, why not make your home your investment? In general, that’s a good idea. Investing is the cornerstone of “retirement planning”. Governments want you to plan for your retirement. As a result, in many countries, the sale of a principal residence is treated as a “tax free” capital gain. Yes, a “tax free” capital gain. This explains why in many countries (including Canada and the U.K.) the principal residence is the most important investment people make. In addition, a “tax free” capital gain allows people to move and buy another house. How are you supposed to ever move, if by selling your house you are forced to give a “chunk” to the government? But, hey you’re an American …
You guessed it. U.S. citizens are NOT allowed a “tax free” capital gain on their principal residence. It’s true. But, every U.S. citizen who sells his principal residence is allowed the first $250,000 gain on a tax free basis. (This means that Americans abroad should move frequently to ensure that their capital gains don’t exceed the $250,000). Understand that if you live in a major city: Examples include Vancouver, Toronto, London, Paris …. and you bought your house many years ago you WILL have to pay the U.S. a “capital gains” tax on the sale of your principal residence. This point was recently illuminated in the “Boris Johnson Chronicles“.
In the pre-Obama years the tax on long term capital gains was 15%. In the new world, it’s either 20% or 23.8% (depending on how your tax preparer views the applicability of President Obama’s new NIIT (Obamacare Tax). (I will probably write a separate chapter on the “ObamaCare Surtaxes and Americans Abroad. After all, Americans abroad really should be paying for the health care of Homelanders, right?)
In any case, this is a very serious problem. In fact, there are many pensioners who are in a position where they are forced to renounce U.S. citizenship (as long as they are NOT “covered expatriates” and subject to the U.S. Exit Tax) in order to be able to sell their house (the tax bite will be too great). No, I am not kidding …
Don’t forget the problem of foreign exchange based (phantom) capital gains discussed below.
Also, if you sell your principal residence at a loss, you will NOT be able to deduct that loss against other capital gains.
Issue 2: Americans abroad and the ownership of investment real estate (second house or small apartment building)
The good news:
Ownership of “rental real estate” is one of the few areas of investment available to Americans abroad that is not subject to punitive taxation and expensive (relative to Homelanders) reporting. So, go for it!
The (possible) bad news:
You should know that the U.S. limits the extent to which “passive losses” (you are running your one rental property at a loss”) can be deducted from other sources of income. These are called the “Passive Activity Loss Rules”. To learn more you should just google “Passive activity loss limitations”. But here is a good article, written in “People Talk” that will give you the basics.
Please note that the “passive activity loss” rules apply to ALL U.S. citizens (not just those living abroad).
Issue 3: Americans abroad, foreign exchange rates and phantom capital gains on mortgages
As you know, the U.S. dollar rises and falls relative to other currencies. All your “non-U.S. real estate” transactions must be converted to the U.S. dollar equivalent. When you purchase “real estate” there are usually two transactions:
First, the purchase and sale of the property itself.
Second, the receipt of mortgage financing and eventual discharge of that financing.
This has the potential for very nasty surprises. I refer you to a recent post by “Eric” at the Isaac Brock Society who explores the history of this problem and links to other posts that provide further discussion.
For the moment:
To be forewarned is to be forearmed!
Issue 4: How should Americans abroad hold title to real estate with a “non-U.S. citizen spouse”
My purpose is to identify this as an issue. Understand that the Internal Revenue Code imposes special restrictions on you if you do NOT marry a U.S. citizen. Leaving aside the obvious offensiveness of this, you must understand, why in the context of the ownership of real estate, this can be a problem. The basic issue is whether to hold the title as “tenants in common” or as “joint tenants”. This is a discussion that you should have with your adviser.
The issue is related to making “gifts”. The Internal Revenue Code allows for unlimited spousal transfers provided that it is a transfer from one U.S. citizen spouse to another U.S. citizen spouse. A gift from a U.S. citizen spouse to an “Alien” can trigger “Gift Tax” issues. I will leave it to you to get the advice you need.
Note: Those Americans abroad with non-U.S. citizen spouses will face a series of problems that do NOT exist if a U.S. citizen is married to a U.S. citizen. This (in an age of disposable marriages) is something worth considering.
On the flip side: It’s also a problem for an “Alien” (non-U.S. citizen) to be married to a U.S. citizen. Think about it!
(Here is an interesting Phil Hodgen article on this topic along with my comment.)
Issue 5: Mortgages – When FATCA and your “USness” will prevent you from getting a mortgage anyway
No, it’s not a myth! Not a myth at all! In fact Americans abroad are being denied mortgages and other banking services because:
1. The United States is punishing banks who deal with U.S. citizens; and
2. You are a U.S. citizen.
One of the plaintiffs in the Bopp FATCA lawsuit was forced to renounce U.S. citizenship in order to save his ability to have a mortgage.*
Much has been written on this. We are in the early stages of problems.
Conclusion …
Those are some thoughts on “non-U.S. real estate” and ownership by Americans abroad. This is not “legal advice”. It is “issue awareness”.
*
Citizenship Taxation - Theory vs. Reality 
It may seem illogical to ban Americans from mortgages, but mortgages do drive FATCA reporting. When you pay for your new home, the payment does not come from a mortgage account. Such accounts only make internal transfers into an account capable of making an external payment — a chequing account. The chequing account is merely a pass-through, yet the highest balance for the year will be at least the value of your mortgage, typically 6-digits.
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