Planning For The Ongoing Tax Burden Of Foreign Property Ownership
Dear Student,
As we discussed in Step #5, when we focused on the tax issues and questions you need to address as you work through your plan to relocate to another country, U.S. citizens have a more complex challenge on this front than other nationalities, because the United States taxes its citizens on their worldwide income no matter where they live.
Today we’re returning to tax issues in the context of investing in a home of your own in your new country of residence. Property ownership can trigger particular tax liabilities. I’ll address the generic ones first (that is, the ones that apply to everyone). Then I’ll walk you through the specific U.S. tax implications you’ll face as an American buying property overseas.
Yesterday I discussed the taxes and other costs that can be associated with purchasing a piece of real estate in a foreign country. Once you’ve made the investment, you can also have an ongoing tax burden. For the most part, in most countries, this amounts to a property tax.
Property taxes in many countries are managed at the local level—by the municipality, as it were, which oversees collections and sometimes sets the rates. This means that, depending on the country, you may need to know where, exactly, you’ll be buying before you can know what your property tax rates might be. Generally speaking, though, property taxes are lower most everywhere in the world than the U.S. average… and not all countries charge them.
Sometimes, a country will exempt certain kinds of properties or certain kinds of purchases from property tax for certain periods of time, to incentivize investment. This was the case in Panama over the past two decades or so, when the government offered a 20-year tax exemption to all new property purchases. (This exemption has since expired.)
A property tax exemption or no property tax at all is great, of course, but property tax shouldn’t be a determining factor for where you decide to relocate or even if you decide eventually to invest in a home of your own. Again, in most of the world, it’s a negligible expense.
One other tax related to owning real estate that you can encounter in some countries is what’s typically referred to as a wealth tax. This is a tax on an individual’s net worth. A wealth tax can be complicated to understand. If you surpass a threshold amount for total value of assets held in a country that imposes a wealth tax, you can be liable for the tax whether you’re a resident or not. As a resident in a country that imposes a wealth tax, you’ll likely be liable for the tax on your worldwide assets.
Croatia is one country that doesn’t charge property tax. Neither does Buenos Aires in Argentina, although the rest of the country does.
Argentina also imposes a wealth tax, so if you own property in Buenos Aires the wealth tax effectively becomes your property tax. France and Uruguay both charge wealth taxes. However, you aren’t liable for the tax on your worldwide assets in France until you’ve been resident for five years.
Bottom line, given the available exemptions in most countries that impose a wealth tax, you aren’t likely to be liable for much actual tax unless your net worth is significant.
The other major tax to consider when investing in a piece of property in another country comes into play only if you rent out the place. In many jurisdictions, rental income is treated like ordinary income. In addition again, in most countries you can deduct direct expenses against gross revenue.
Typically, you’ll have to file a tax return in the country at the end of the year to report the rental income and to show the tax owed. Some countries, though, have figured out the foreign property owners don’t always report rental revenues. This has led some countries to impose taxes at the source. Practically speaking, this means that in some places your property/rental manager will be meant to hold out some percentage of the rental income you earn and hand it over to the government’s tax authority. These withholding rates are typically onerous, with the intent of motivating you to file a full and proper income tax return at the end of the year (often to claim back some of the withholding as a refund).
Some governments have gone so far as to make a proactive presumption that any non-primary residence is a rental. They then charge you tax on a presumed rental value/income for your property. Spain does this. With so many foreign property owners, who use their condos and villas only part-time and rent them out otherwise, the government wants to be sure it’s getting a piece of all the rental income being generated within its jurisdiction.
The flaw in this approach is obvious. Not every non-primary residence is a rental and certainly not every non-primary residence is rented out full-time. If you have a holiday home on the Spanish costa that you allow to sit empty when they aren’t using it… you’re not liking this Spanish government tax policy.
Most countries allow you to deduct direct and related expenses against your rental income—including mortgage interest, management expenses, utilities if you’re paying them (this would be the case for short-term rentals, for example), and any other direct expenses. What most countries don’t allow you to deduct is depreciation. This is a U.S. accounting phenomenon that is also allowed for U.S. tax calculations…but typically not elsewhere.
If you are a U.S. citizen holding a rental property in another country, it’s treated more or less the same as a U.S. rental property for U.S. tax purposes. You are allowed the same expense deductions, including depreciation and the cost of travel to visit and check on the property. You report the rental income on a Schedule E, as you would for any U.S. rental.
The complications for an American can arise from the tax liability in the country where the property is located. Without depreciation as an expense, you may have a profit in the foreign country and a loss on your U.S. taxes. The tax you pay in the foreign country can be used as a tax credit against any tax owed to Uncle Sam for the same income. If you don’t have any net income in the United States, due to depreciation expense, then you have to carry forward the tax credit. Eventually, you may be able to use it.
If you’re an American holding foreign property in your own name, that’s really the only difference for your U.S. tax-reporting requirements.
Which leads to the question… should you hold your foreign real estate in your own name?
Tune in here for the answer tomorrow… when I’ll walk you through different ownership structures you should consider for holding your foreign property assets.
Kathleen Peddicord
Your New Life Overseas Coach