In 2010, IRS regulations known as FATCA (Foreign Account Tax Compliance) were made law. These regulations require that US Citizens living either in the US or abroad, report their foreign account holdings to the IRS. Of course, there are many considerations regarding the amount held abroad, the type of asset, and the type of ownership. All this will be explained fully in this blog.
Another type of reporting that is required for US citizens that own assets abroad is called FBAR (Foreign Bank and Financial Accounts). This reporting requirement was made law in 1970 under the Bank Secrecy Act. It is not a reporting requirement of the IRS, but is associated with the US Department of the Treasury. It must be reported online. This too will be explained in more depth in this blog.
Before I go into details on FATCA and FBAR, I need to highlight the situation regarding real estate. Neither the FBAR nor the FATCA regulations requires you to report any foreign real estate you own! FATCA and FBAR are concerned with bank and financial assets, not real estate.
One final note on owning real estate abroad. If you purchased real estate abroad and placed the title and ownership inside a foreign corporation, rather than in your own name or a US based company, then you typically will have a CFC (Controlled Foreign Corporation). This does not require FATCA or FBAR reporting, but it does require you to include Form 5471 on your US federal tax return as the owner of your CFC.
There is one other type of form (Form 8621) that a US taxpayer might be required to file if they own shares in a foreign company that is deemed by the Treasury to be a Passive Foreign Investment Company (PFIC). For real estate investors or people buying real estate for their own use, this form will not be required.
FATCA
FATCA reporting is handled via form 8938. If you have foreign financial assets, other than real estate, held in a foreign account with a bank, trust, or other entity, and the total value of all your accounts abroad reach a certain threshold, then you must file form 8938 with your federal tax return. There are a few other considerations depending on your circumstances, so you should definitely consult with your CPA.
Most Common Types of Foreign financial assets:
- Savings, deposit, checking, and brokerage accounts held with a foreign bank or broker-dealer
- Stock or securities issued by a foreign corporation
- A note, bond or debenture issued by a foreign person
- A partnership interest in a foreign partnership
- An interest in a foreign retirement plan or deferred compensation plan
- Any interest in a foreign-issued insurance contract or annuity with a cash-surrender value
FATCA Compliance Thresholds
Filing thresholds differ depending on where you lived during the tax year.
If you live within the U.S. the entire tax year, you must file Form 8938 if the value of your reportable foreign assets exceeds either of these levels:
- More than $50,000 (or $100,000 if married filing jointly) at the end of the year, or
- More than $75,000 (or $150,000 if married filing jointly) at any time in the year
Expats living abroad have an increased reporting threshold. You don’t need to complete this form unless your foreign assets exceed either:
- $200,000 (or $400,000 if married filing jointly) at the end of the year, or
- $300,000 (or $600,000 if married filing jointly) at any time during the year
FBAR
FBAR uses form 114 to report certain financial account holdings in foreign countries. Whether you live in the U.S. or abroad, every U.S. person (U.S. citizens, green card holders, resident aliens) or US based company, is required to file form 114 if they are an owner or can control the distribution of a foreign financial account’s funds (signature authority). If the combined balance of all your foreign accounts is more than $10,000 at any point during the calendar year, you must file the form.
Foreign financial accounts to be reported on the FBAR include: bank accounts, securities accounts, retirement accounts, annuities, life insurance policies with cash value, and other financial accounts.
The FBAR form (114) is due the same day as your tax return, but it is not filed with your tax return. It is a separate filing that must be e-filed with the Treasury Department using an electronic filing system.
PFIC and form 8621
The federal government has been working on ways to track and tax the foreign assets of U.S. taxpayers for decades. The Tax Reform Act of 1986 created additional reporting and tax implications for the shareholders of Passive Foreign Investment Companies (PFICs). Originally, this law was supposed to remove advantages for shareholders investing in foreign mutual funds over U.S.-based funds. However, over time, the extremely complex laws related to PFICs have encompassed a variety of overseas business interests.
In general terms, the Internal Revenue Code defines a PFIC as a foreign corporation which has either:
- At least 75% of its gross income is passive income
- At least 50% of its total assets are passive assets – assets that don’t produce business income
What is Passive Income?
To determine if your company qualifies as a PFIC, you will need to distinguish active and passive income generated by the business. Passive income includes:
- Interest
- Dividends
- Royalties
- Annuities
- Commodities
- Foreign currency gains
- Disposition (sale or transfer) of any of these assets
- Notional principal contracts
- Some rents
Rent is considered passive unless it comes from a related person (such as an officer or shareholder) or is a part of the active conduct of the business including rent from:
- Leasing property produced by the company
- Real property managed or operated by the company
- Personal property leased when it would otherwise be idle
- Adjunct to the foreign company’s marketing business
Real estate investing with companies that offer agricultural interests and income, or short term rental income, or participation in any kind of real estate development will not be subject to PFIC filing requirements. Any investment that we look at will not require filing under PFIC.
Examples
You buy a small house in your name for $300,000 in San Miguel de Allende and rent it out most of the year in the short term rental market. You have a bank account with $6,000 average balance.
- FBAR reporting is not required for either the real estate or the bank account. The bank account does not reach the reporting threshold.
- FATCA is not required for the real estate, and the bank account does not reach the reporting threshold for FATCA.
You invest with LIFEAFAR on a condo project in Medellin. You live in the US and file a joint return. Your investment balance held with Lifeafar is $105,000 at year end.
- No FBAR is required since you do not have signature authority over your funds.
- FATCA is required since it is a foreign asset and is valued over the threshold for Americans filing jointly who reside in the US.
You, as an individual taxpayer living in the US, invest in a farming operation for $50,000 in Panama where you own the land and let the farm manage it for you and they pay you a portion of the profits every month.
- No FBAR is required since you do not have signature authority over your funds.
- No FATCA is required since your foreign asset is real estate. The income is reportable as farm income using form 4835.
You own a condo in Ambergris Caye in Belize valued at $250,000, you live there part-time and you have a bank account in Belize with $25,000 average balance.
- FBAR is required as you have over $10,000 in a foreign bank
- FATCA is not required for the real estate, and the bank account does not reach the reporting threshold for FATCA.
US Tax on Income from Foreign Sources
Income from outside the US can come from many sources; rental income from a foreign property, investment income from an investment in a foreign company or foreign stocks and bonds, and earned income from working in another country,
Rental income from foreign owned real estate must be declared on US tax returns and it is taxed the same as rental income from real estate held in the U.S. This is done on schedule E, form 1040, or via your company’s tax return, if you own foreign real estate through a company. But you will have some deductions available that can be deducted from this income: foreign property taxes, insurance, mortgage interest, repair and maintenance expenses, and travel expenses required to maintain your foreign rental property. You can use a yearly average exchange rate that the IRS posts every year to convert your local currency expenses to US dollars.
If foreign taxes are paid on foreign rental property income, US taxpayers can claim US tax credits on a dollar for dollar basis to reduce the US tax due on their rental income. To claim these tax credits, use form 1116 with the federal return.
Foreign owned property uses a 30 year depreciation schedule for residential property, not the 27.5 year schedule used for domestic residential real property.
Other income from foreign investments are taxed the same as the US investments. There may be some deductions available for any costs associated with the income, but not like there are for rental properties.
US Tax on Selling Assets Abroad
Capital gains or losses from selling a property abroad must be reported on US taxes, and are very similar to the rules for selling a US property. Just as you must do with income, you must convert your sale to US dollars. Use the IRS table of average exchange rates for the country you had the property.
Just like in the US, if you own property abroad and live in it as your primary residence, you can exclude some or all of the US capital gain, depending on your filing status and length of ownership. If you pay a capital gain tax to the local government, you can only get a tax credit for taxes on gains above any US exclusion.
If you sell a rental property, you have to pay capital gains in the US same as a rental property held in the US. There are no exclusions like the one for a primary residence. But if you also paid local capital gains taxes to the foreign government, you can get a tax credit for those payments. You calculate your capital gain or loss using the tax basis just like US property. If you depreciated your property, this will increase your capital gain by reducing your basis.
Capital gains are passive income, not earned income, so there won’t be any exclusion under the Foreign Earned Income Exclusion rules.
Capital Loses can be used to offset other capital gains, but not earned income.
Just like a US property, a foreign property will be taxed differently depending on if it is short term or long term, and depending in what tax bracket the tax payer is in. Foreign real estate sales have the same capital gains tax rates as domestic real estate sales.
You cannot do a 1031 exchange between a foreign property and a US property. You can only use the 1031 exchange mechanism for a foreign property with another foreign property.