If you are considering working, retiring, or marrying overseas, you must have questions about how to best manage your financial affairs back in the US.
In the second post of this series I’ll call “what to do when I move overseas”, we will discuss what to do with your US real estate when you move overseas.
(You might also be interested in the first post of this series: What to do with my US investment accounts when I move overseas.)
Generally speaking, you are able to continue to own the real estate the same way as if you are still living in the US full-time. The real estate title records your legal ownership of the property, and you continue to pay off a mortgage if you have one.
What to do with my US real estate when I move overseas?
What doesn’t change
If you hold an investment property in the US, you need to declare rental income whether you live in the US or maintain tax residency. As a US tax resident overseas, you only get a federal tax exclusion on earned Income, not income generated through owning US property.
The good news is that owning an investment property can be considered a business activity. This means that you are able to deduct expenses, including maintenance, mortgage interest, and even depreciation on the property, from rental income. In effect, you only pay taxes on the “profit.” For some people, after all the deductions you may have no profit so you do not have a current tax liability until you sell the property. At sale, you will pay taxes on capital gains and depreciation recapture.
You also continue to pay state-based property taxes and most likely rental profit connected to the in-state property.
So what changes when you own US-based properties while living overseas? The main points of planning consideration that have significant financial implications are:
- Are you turning a primary residence into an investment property by moving overseas?
- Are you becoming a tax resident in another country?
- Are you giving up US citizenship or permanent residency after moving overseas?
Turning primary residence into investment property
If you will rent out your US-based home, you will turn your primary residence into investment property. Currently the US tax code has favorable treatment toward capital gains when you sell a primary residence. If the property is considered a primary residence when you sell, each spouse excludes $250,000 from capital gains. This means many people don’t pay taxes when they sell their home.
Right now in order to qualify for the exclusion, you need to live in the property in two out of the last five years, or qualify under special circumstances.
If you own a home that has significantly appreciated and have no reason to own the property for the long-term, you may want to consider selling the property while you still qualify for exclusion. Of course, avoiding taxes shouldn’t be your ultimate goal. You should do the calculation on the potential return after taxes before you make the decision.
In addition, if there is a possibility that you may return to live in your US home again, you may again start the clock on counting it as your primary residence. IRS has a specific formula to calculate the pro-rata share of capital gain that may be excluded from taxes.
Lastly, owning the property may also play in the decision of which state you want to maintain residency. Some states have property tax relief if you are a resident, but may require you to pay income taxes on your overseas income. Do an overall analysis on which state to maintain residency to minimize the overall cost.
Tax liability in another country
Another consideration is whether your rental income will be taxed in your new resident country. Some countries have a tax treaty with the US that covers what country gets the revenue. Most of the time under the treaties, you pay taxes in the country where the business income is generated. Confirm this for the country you live in.
Without a treaty, it is possible your new resident country may tax your worldwide income, not just income derived from your residency. You need to find out whether to report your US-based rental income in another country, and whether it is considered a business activity so you are able to deduct expenses.
The good news is that under the US system, if you have paid income taxes to another country on the same income that you get taxed on in the US, you are able to receive a foreign tax credit. This will reduce your US tax liability.
If your move overseas is long-term, you may also need to plan for estate tax and transfer in the event of your passing. Many neglect this part because they are young or plan to return to the US, but there is always a possibility for unexpected death overseas.
Again, if your new tax resident country has a treaty with the US, consult the specific rules on which country handles the property in your estate. After the new tax reform takes effect, most people will not have to worry about estate taxes at the federal level. However, your other tax resident country may impose a tax on all estate transfers even for assets outside of the country. Make sure you understand the rules and work with a qualified local estate attorney to structure the transfer in legal documents.
It is likely if you remain overseas that you will need two sets of estate documents, one for the US and one for the other country. Make sure those two sets of instructions are coordinated and comply with the laws in each country.
Own US property as Non-resident Alien
So far what we’ve discussed mostly applies to US tax residents moving overseas but retaining citizenship or permanent residency. What if you are exiting permanently?
As you may be aware, there are many foreign investors that own US investment properties and make the news, so you definitely are able to do it. The question is, how do you structure it to minimize the cost and maximize the return.
First of all, owning US real property as a non-resident alien (NRA) has the following upsides and downsides:
- If you own the property directly, or through a US corporation or trust, you will be subject to US estate taxes without the exemption available for US citizens. The estate tax schedule is pretty steep so most people want to avoid it.
- You are also subject to the US gift tax if you gift the real estate ownership directly before death. However, if you own the property through partnership or company, gifting corporate stocks or partnership interest is not taxable.
- Rent received by NRA on US property is taxable as US-sourced income, and may be considered effectively connected to business or trade.
- Under FIRPTA, NRAs selling real estate are subject to U.S. income tax, usually at capital gains rates. There is also a mandatory withholding requirement from rental income or sales proceeds. This requires the NRA to file tax returns to receive a refund.
If you are already dizzy from reading this, you are not alone. Real estate investing from foreign nationals is historically an area of scrutiny. The government focused a lot on getting tax revenue from foreign nationals, who have no representation in the congress. If you become part of this cohort, I recommend that you find a competent real estate attorney to structure the holdings for you before you renounce your citizenship or give up your green card.
Here is a resource on the pros and cons of ownership structure for NRA to hold US-based properties. Note that depending on what you want to accomplish and the size of your asset base, what’s best for billionaires with assets across the world may not be the best for you. There is not one solution that has no negative side, so it’s a matter of tradeoffs.
Lastly, as mentioned in the previous post, before you renounce citizenship or give up your green card, make sure you take the steps to avoid becoming a covered expatriate. You can read up on how to avoid being one, and the unfavorable treatment from the IRS if you do become one. Most of all, if you do become one, there is no way to ratify that situation, so before you make the appointment at the US embassy or consulate, make sure you’ve done proper US tax planning.