Can Overseas Property Help Limit Your U.S. Tax Liability?

Americans abroad are at a disadvantage when it comes to taxes because, unlike the majority of developed nations, the United States operates a citizenship-based taxation system instead of a residence-based one.

This means that, no matter where you move, so long as you maintain your U.S. citizenship, you will have to file an annual tax return with the IRS, even if it’s just to tell them that you don’t owe any money.

While you will always have to file, you should never pay more in taxes than you’re required to. Certain offshore strategies, like owning property overseas, can help you legally limit your U.S. tax liability.

Here are the top U.S. tax benefits that owning overseas property can bring.

It Provides Privacy Advantages

Property outside of the United States is one of the few assets that Americans don’t have to declare on their U.S. tax filings.

The others are physical precious metals (with some exceptions) and collectibles (art, antiques, jewelry, and rare vehicles).

These can all be major stores of wealth, but overseas property provides the strongest lifestyle benefits, assuming you enjoy travel and adventure.

A home in another country can provide free vacations in culturally vibrant and exciting locations, and it can generate income and capital appreciation.

Exclusions And Deductions

If you invest in rental property overseas, it’ll be treated more or less the same as U.S. rental property for U.S. tax purposes. You report the rental income on a Schedule E, as you would for U.S. rental income.

You’re allowed the same expense deductions, plus you can deduct the cost of every trip you take to check on your property on your U.S. tax return. This is a benefit of buying investment property in places where you also enjoy spending time.

It’s also possible to deduct the interest paid on your mortgage for your foreign home from your taxable income. Depreciation can also be deducted, although you have to use a 40-year schedule for foreign property.

If you’re a U.S. expat earning overseas, the Foreign Housing Exclusion (FHE) allows you to exclude thousands in foreign housing expenses from your U.S. taxes.

For the 2022 tax year, the standard housing exclusion is $15,680 (14% of the Foreign Earned Income Exclusion (FEIE)). However, you could exclude a much larger amount, depending on where you live.

The IRS issues an annual notice identifying countries and locations within those countries where housing costs are high relative to those in the United States, allowing for a larger exclusion.

The FHE can include rent, housing provided in kind by an employer, utilities, insurance, occupancy taxes, household repairs, residential parking, and more.

Foreign Tax Credit

A foreign tax credit (FTC) can reduce the amount of U.S. income tax payable by any foreign tax paid on your entire income (not just earned income). It also reduces double taxation.

FTC works for all earned income, not personal earned income. Foreign earned interest, dividends, rent, capital gains, etc. are all income.

You can’t claim FEIE and FTC on the same income, but in specific circumstances, you can claim some of the excess over the FEIE through FTC.

1031 Like-Kind Exchange

Another tax benefit of overseas property is the 1031 like-kind exchange, a kind of tax loophole that lets you defer tax on your gains by reinvesting the proceeds from the sale of one property into the purchase of another (following specific rules).

For this loophole to work, you need to have sold foreign property and be reinvesting it in foreign property. (You can’t, for instance, sell U.S. property and use it to buy foreign property.)

Also, it has to make sense from an investment perspective, which it can if the country where you’re selling property does not charge capital gains tax.

If you’re selling property in a country that does charge capital gains tax, it’s probably more advantageous to take the credit for the taxes paid in the other country.

Access To Low-Tax Jurisdictions

In certain countries (the Dominican Republic, Belize, Panama, Greece, Montenegro, and Northern Cyprus, to name a few), a property purchase can qualify you for temporary residency.

If you’re willing to relocate overseas, you can optimize your tax situation by buying property in a country that offers residency-by-investment and is also a low-tax jurisdiction.

Panama and Belize are two of the top choices for this. Both countries tax jurisdictionally, which means that they only tax you on income earned in that country, even as a resident.

By relocating to a low-tax jurisdiction, it can be possible to organize your affairs in a way that can reduce or even eliminate your tax burden.

Tax Disadvantages Of Overseas Property For Americans

Additional U.S. Tax Obligations

You may need a local bank account in the place where you’ve invested in property to pay local bills or deposit money. Because of the Foreign Account Tax Compliance Act (FATCA), you may find it difficult to find a foreign bank that’s willing to take you on as a client.

FATCA requires banks around the world to disclose account information for American clients with $50,000 or more in their accounts to the IRS. The global banking industry has to comply with FATCA if it wants to do business in the United States.

Banks have either figured out how to do this or have dropped all their American clients. Today, fewer international banks will take on American clients and those that do have higher fees to cover FATCA-associated overheads.

If you manage to open a foreign bank account, you’ll have to file a Foreign Bank and Financial Accounts (FBAR) form if you hold $10,000 in your account (or across multiple accounts) at any time. Failure to report can result in financial penalties.

Overseas Tax Liabilities

Owning property in another country can trigger local tax liabilities—both when you buy and when you sell, as well as ongoing taxes.

These are the top property-related taxes that you need to consider:

• Property tax. Generally speaking, property taxes are lower overseas than they are in the United States. Some countries don’t impose them at all.
• Property transfer tax. This can be more significant. In many countries, the buyer pays a government transfer tax that can range from 1% to 10%.
• Taxes on rental income. Many countries treat this as regular income for tax purposes, and you’ll need to file a tax return in that country to show the tax owed. In some cases, taxation on rental income can be more complicated than this. Spain, for instance, makes the presumption that any nonprimary residence is a rental and charges you tax on a presumed rental value for your property, which is not ideal if you have a holiday home in Spain that you allow to sit empty.
• Capital gains tax. This is another cost to understand before you buy in any market. Not all countries charge capital gains tax on real estate profits. As an American, you owe capital gains taxes in the United States even if no capital gains tax is charged in the foreign country.

Having a local tax burden in another country does not mean that, as a U.S. person living or investing overseas, you’ll owe tax in two countries. Double taxation treaties almost always eliminate the possibility that both your new country of residency and your home country will demand a tax from you on the same income.