When you are renting out your real property in a foreign country, as a US Citizen or permanent resident, you must not only comply with all tax requirements of that foreign country, but you must also report all rental information on your US income tax return. The rules are almost the same as those for rental property located in the US, but with some variations.
- If you own the Mexican rental in your individual name, you report all of your rental income and expenses on Schedule E of your Form 1040. All of the allowable expenses are the same as for US property.
- Expenses you can deduct include management fees, interest, property taxes, utilities, repairs, maintenance, association dues, insurance, depreciation, and other miscellaneous expenses.
- Unlike property located in the US, you must depreciate the property (amount allocatable to the structure) over a 40 year period rather than shorter times sometimes allowed for US property.
- You can take a credit against your US federal income tax for income taxes paid to the foreign country on your net rental income after deducting all expenses. That credit is limited to the amount of US Federal tax you paid on that rental income on your tax return. Any unused foreign tax credit can be carried over to future year. Most US states do not allow any credit for income taxes paid foreign countries.
- Any Value Added Tax (VAT) or occupancy tax collected from the renter should be included in your rental income, but then you can deduct out those taxes so you do not have to pay any tax on those items.
- The same restrictions and limited allowable deductions for “vacation homes” apply when you have occupied the property yourself part of the time and rented it out to third parties at other times.
- When the property is sold (if it is held in your individual name ) your net gain is taxed in the US at the applicable lower capital gains rates, and you can claim a credit against your US tax on the sale for the foreign capital gains or income taxes paid on that profit to Mexico.
If the property was used for the 2 years during the previous 5 years prior to sale as your personal primary residence (you must actually live in it full time during that period), you may be able to exclude up to $500,000 of the gain from your US income taxes under the exclusion allowed for sales of personal residences. If the property was rented out part of that time, some of the gain on sale will be subject to US income tax.
If your foreign real property is held through a foreign corporation, there can be adverse US tax consequences while renting out the property and upon sale on your US tax return. With the proper type of foreign corporation, certain elections can be made with the IRS which will negate almost of these US tax problems. These elections are only made for US tax purposes and do not in any way affect the way your foreign corporation is taxed under the tax laws of its country of location.
Other US Tax Forms That May be Required:
Form 8865: If you own your foreign rental in a foreign partnership (if you own 10% or more) or LLC you must filed this form each year with your personal tax return to report the details of its income, expenses, etc.
Forms 3520/3520A: If you own your foreign rental property or personal residence in a foreign trust, you must file both of these forms each year. They are not filed with your personal tax return. One form is due 3/15 after the end of the calendar year and the other is due on the extended due date of your personal tax return. Failure to file these forms can result in extreme penalties.
Form 5471: If your foreign real estate is held in a foreign corporation, you must file this form each year if you own 10% or more of the shares (actually or constructively) in the corporation. This form is due on the extended due date of your personal return. The IRS can impose a $10,000 per year penalty for filing this form late or not at all.
Form TDF 90-22.1: This form reports your ownership in foreign bank and other financial accounts. It would include any accounts where your property manager or accountant is using to collect rents or pay foreign taxes and rentals. If the highest total of all of your foreign financial and bank accounts when combined together equal or exceed at any time $10,000 US per year, you must file this form to report details of all accounts. It is filed separately from your tax return and is due on June 30th following the end of each calendar year. The due date cannot be extended. The IRS can impose a $10,000 penalty for filing the form late or not at all.
About the author: Don D. Nelson is a US Attorney and CPA who has specialized in helping Americans living and working in foreign countries with their US Tax planning and compliance for the last 20 years.
- Foreign Offshore & US Tax Planning
- US Tax Return Preparation (including all US states)
- Foreign Trust US Tax Form Preparation
- Foreign Corporation & Foreign Partnership US Return Preparation
- Foreign Bank & Financial Account Reporting (FBAR) Form Preparation
- Expatriate and International Tax Forms Prepared
- Consultation on US tax aspects of owning property and operating a businesses in any country in the world