How Not To Pay Taxes As An International Property Investor
Real estate investors have a lot of taxes to worry about–property taxes, income taxes on rental income, transfer taxes at purchase, and capital gains taxes when you sell. As an international real estate investor, however, you don’t have to worry about all these taxes in every jurisdiction. Not every country charges property taxes and not every country imposes capital gains taxes. Ireland and Croatia are two examples of jurisdictions where you’ll pay no property taxes. France charges property taxes, but the amounts are low. You pay no property tax in Buenos Aires (though you do in the rest of the country), but Argentina imposes a wealth tax.
New Zealand doesn’t have a capital gains tax for real estate. In France, the capital gains tax decreases after 5 years of ownership and disappears after 15. Hold your property in Croatia in your own name for at least three years, and you pay no capital gains tax when you sell. Title the property in the name of a company in Croatia, on the other hand, and you will owe capital gains tax when you sell.
Keeping track of the rules country by country can get confusing. Especially if you hold property in multiple jurisdictions at the same time. And especially if you are a U.S. citizen. As we continually point out, U.S. citizens (actually U.S. persons, including green card holders) are taxed on their worldwide income. This includes capital gains on real estate sales, including international real estate sales.
Experienced real estate investors in the United States know about the IRS loophole for deferring capital gains taxes. It’s called the “like-kind exchange.” It’s available for other things, too, but used most often for real estate. Rules and restrictions apply, but the bottom line is that, using the like-kind exchange, you can take the proceeds from the sale of one investment property and roll them over into the purchase of another, thereby deferring the capital gains tax hit.
You can continue this roll over, reinvesting, reinvesting, and reinvesting until you die. At that point, your heirs get a stepped-up basis, and estate taxes are the only hit you take.
The U.S. investor can use the like-kind exchange rules for non-U.S. real estate, as well as for property within the States. You can’t exchange U.S. for foreign or vice-versa, but you can exchange foreign for foreign. That is, after you’ve sold your first international property investment, you can continue to roll over your capital gains into other non-U.S. property buys indefinitely.
If you sell a piece of property in a country that charges taxes on capital gains, then you likely do not want to bother with a like-kind exchange for U.S. tax purposes. As you are paying local taxes (in Country A) on the gain, deferring your recognition of the gain in the States eliminates your ability to offset the tax you paid in Country A against any U.S. tax owed on that transaction.
Say, for example, you own a rental property in Spain. You sell that property and pay the 18% tax on the capital gain due in Spain. The capital gains tax in the U.S. is only 15%. In other words, you have the opportunity to wipe out the U.S. tax with a tax credit for the tax paid to Spain, but only if you recognize the gain immediately on your U.S. taxes. You’d recognize the gain in the States, but you’d owe no tax in the U.S.–meaning there’d be no reason to go through the administrative hassle and expense of a like-kind exchange.
The like-kind exchange makes sense only in countries that do not impose tax on real estate capital gains (see the references I made above for examples). Sell tax-free in New Zealand, for example, and use the like-kind exchange rules to defer your tax hit in the States. This makes sense because you have no offsetting tax to bring to bear.
Thinking ahead, what if you use your New Zealand property proceeds to invest in real estate in a country that does tax capital gains? As I said, you’ve got to figure the consequences case by case.
Also consider, before initiating a like-kind exchange of foreign property, the rules you have to follow. It’s not hard to fall out of the window allowed for identifying and closing on a new property purchase (if you have local complications with the closing process, for example). Miss the window for selecting your exchange property option or the deadline for closing on the new property, and the exchange will be ruled invalid by the IRS. Meaning the effort and expense will have been in vain, and you’ll be liable for U.S. capital gains.
You can find plenty of information available online about like-kind exchanges, but it’s typically not the full story. That’s why I’m writing a report for members of my new Marketwatch real estate investing service. This is an important topic that deserves more thoughtful coverage.
In addition, members of my new service will be able to ask me questions as well. I’m building in some one-to-one consulting time.
P.S. If you’re a non-U.S. investor, your situation is less complicated. Focus on countries that impose no capital gains tax, and you can grow your wealth faster.