Americans are taxed on their worldwide income no matter where in the world they’re living.
If you are American and you invest in a cash-flowing property overseas—even if you move to the location to manage your rental directly—you’ll have to file a tax return with the IRS annually.
Nothing you can do about that… except be sure you understand the implications, the consequences, the associated requirements, and the relevant opportunities.
Because being required to file a tax return with Uncle Sam does not necessarily mean that you owe them money… though you could.
You may also have a tax filing and/or a tax payment requirement in the country where the property is located.
The possible permutations for what your tax situation might look like in the United States and in the countries where you might invest are many.
You need professional, experienced help to navigate the liabilities to ensure you don’t pay $1 more in tax—in any jurisdiction—than you must.
In the United States, you report rental income from properties overseas as you would report income from U.S. rental properties—that is, on Schedule E.
You can take the same deductions for an overseas property as you would for one in the United States, with the exception of depreciation. It’s calculated on a 40-year schedule for foreign properties.
If you invest in a farm property and aren’t doing the farming yourself, the income should qualify as farm rental income category, meaning you report it on Form 4835. Do the farm work yourself, and the income is reported on Schedule F.
The important difference is that Schedule F income is charged self-employment tax. Don’t let your accountant tell you that you have to use Schedule F to report income from an agricultural investment when you’re not doing the farm work yourself.
One benefit of buying an investment property in a place where you like spending time—as I strongly recommend you do—is that you can deduct travel expenses associated with checking on the property’s management.
In the country where the property is located, your tax liability depends on whether or not you’re living there. Spain, for example, charges 24% tax on gross rental income earned by a non-EU resident. Live in Spain or another EU (or EEA) country, and the tax is 19% of the net rental income earned (deductions aren’t the same as you are allowed in the United States).
Other countries tax at source—that is, as the rental income is earned.
Income from the rental we owned in Portugal was taxed at 25% after deducting the rental management fee. Our rental manager figured the tax and sent the amount owed to the Portuguese government. We got the balance. That was our only income in Portugal, so no annual tax return was required.
Some countries treat rental income like regular income for foreigners. As there’s typically a minimum threshold before income tax is charged, you may not owe any tax on your rental income.
In Panama, for example, the rate is 0% up to $11,000 of income. If your net rental income is less than $11,000, you owe no tax. However, you’re still meant to file a tax return to report the income.
In a few cases, you may not owe any tax no matter how much revenue you earn. Income from timber investments is tax exempt in many countries if the project is properly registered. Panama doesn’t tax revenue from agriculture if the gross income for the farm is less than $350,000.
Remember, though, that, if you’re American, you’ll still be taxed on that income in the United States.
For any tax you pay to another country for revenue that is also taxable in the United States, you should be able to take a foreign tax credit on your U.S. tax return. Do this on Form 1116.
As depreciation of the property is allowed for U.S. taxes but is not allowed in many other countries, it’s possible you could have less taxable income in the United States than you do in the other jurisdiction. Any foreign taxes that you can’t take a credit for in one year can be carried forward to future years. If you do your own taxes on a program like TurboTax, the program can take care of the calculations and any carry-forward amounts.
What about capital gains tax?
Not all countries charge it on real estate gains. Most that do impose a special capital gains rate, but a few tax capital gains as ordinary income.
New Zealand doesn’t tax capital gains on real estate.
In France, you’ll pay tax on capital gains from the sale of real estate according to a schedule that reduces the amount owed starting after five years of ownership. Hold the property for 22 years or more, and the capital gains tax is zero when you sell.
Unfortunately, France has implemented an additional social tax on gains. This also is reduced over the time you own the property, starting with the sixth year, but it doesn’t go away completely until you’ve owned the property for 30 years.
Some countries apply an inflation rate to adjust the gain calculation so it’s based on a current value of the original purchase price. Some have exemption amounts that reduce the taxable gains.
Americans are liable for capital gains tax in the United States no matter where they live or where the property overseas is located. However, the foreign tax credit comes into play here, as well, and you shouldn’t pay more in capital gains taxes than the highest applicable tax rate.
For example, if you’re taxed 10% on your gain in the foreign country and you fall into the 15% capital gains tax rate in the United States, you’d owe the IRS the 5% difference. Some deductions are allowed when calculating the gain.
Until next time,
Founding Publisher, Overseas Opportunity Letter
