Income Tax and Foreign Rental Property Depreciation: A Guide for American Investors

Last Updated on February 20, 2024 by Kristina Valcheva

Buying property overseas can be an attractive opportunity for American investors to generate additional income.

However, navigating the complexities of foreign rental income tax and foreign rental property depreciation rules can be challenging without the right knowledge and guidance.

Therefore, it is crucial to understand the overseas rental income tax implications and the concept of depreciation when it comes to owning and renting out properties abroad.

In this comprehensive guide, we will delve into the intricacies of foreign rental income tax calculation and depreciation, providing American investors with a clear understanding of the key concepts and important considerations.

Whether you already own foreign rental property or are contemplating an investment overseas, this article will equip you with the necessary knowledge to make informed decisions and optimize your tax strategy.

Key Takeaways

- Foreign rental property owned by a US resident is subject to US taxation.

- You are obliged to file two income tax returns – one in the US and one in the country where your property is located.

- If you operate your home abroad as a rental property, you will often pay foreign taxes on your foreign rental property income, while the same income is subject to tax here in the US. Luckily, taxes paid or accrued to a foreign country can be used to offset US taxes through the Foreign Tax Credit.

- Due to double taxation agreements, you can avoid being taxed twice. Our tax experts can help you with this and with the rest of the paperwork.

- You must file a tax return even if your property has made a loss.

- By taking depreciation into account, your tax liability can be reduced to zero since the net income will also be zero.

- US residents are taxed on their worldwide income similar to US citizens. Non-resident aliens are taxed only on their income from sources within the United States.

Do US citizens have to report foreign real estate?

Certainly! You are required to disclose foreign properties on your US tax return in the same way that you would report any domestically owned property.

US income tax on rental property for non-residents

I have a foreign rental property. Do I have to report this income to the IRS?

Yes. In the realm of taxation, the United States has carved out its path by levying taxes on its citizens’ income earned globally.

This means that if you’re a US citizen and happen to earn foreign rental income from a property located outside the borders of the United States, you’ll need to take that income into account when filing your tax return.

It is essential to report this income both in the US and in the country where your property is located. By fulfilling your tax reporting requirements in both jurisdictions, you can ensure compliance and minimize the risk of facing penalties or legal complications.

But there is good news.

By leveraging the double taxation agreements that the US has established with other countries, you can effectively avoid paying taxes in both countries.

Our tax experts can help you file tax returns in both tax jurisdictions and avoid double taxation if your property is located in any of the countries listed below. Check out our services and fees:

French rental income tax for non-residents
Spanish rental income tax for non-residents
Irish rental income tax (for residents and non-residents)
US rental income tax (for residents and non-residents)
UK rental income tax (for residents and non-residents)
German rental income tax (for non-residents only)
Hungarian rental income tax (for non-residents)
Polish rental income tax (for non-residents)

Got questions?

Request a free no-obligation consultation with a tax expert.

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How do I report foreign rental income?

If you make money by renting out a property in a different country, you must pay taxes on the rental income. The specific tax requirements will depend on your residency status and the existence of any double taxation agreements.

Expert advice:

If you have to pay taxes on your income earned from abroad (including capital gains taxes from selling a foreign rental property), there is a possibility to offset the US income taxes paid on this foreign income.

By utilizing a Foreign Tax Credit, you can prevent the real estate income from being subjected to double taxation.

Suppose you paid or incurred $100 in income tax in a foreign country. In most cases, you can subtract that $100 from your domestic tax liability. However, there is a maximum limit to the tax credit you can claim.

If you happen to be the sole owner of the property, excluding any corporate or trust ownership structure, then congratulations!

In such cases, you will be required to report your overseas rental income to the IRS on Form 1040 Schedule E. Depending on your circumstances, you might need to add additional forms and/or schedules.

If you own the property through a US LLC (limited liability company) with multiple members (excluding LLCs formed by spouses in US community property states), or through a foreign corporation, partnership, or trust, you will need to fulfill extra filing and reporting obligations.

These may involve submitting Forms 1120, 1065, 5471, 8865, or 1041, among others.

However, if you have inherited the property, it is crucial to determine the type of ownership you hold. Inherited properties carry the same reporting requirements as properties purchased outright.

Additionally, if the property’s value exceeds $100,000 and the deceased individual was not a U.S. citizen or resident, you will need to file Form 3520 to meet the necessary reporting obligations.

To report your income gains and losses, start by converting all currencies to USD. Next, determine the number of days you rented out your property or lived in it. This will help determine how your taxes will be treated.

Owner’s Usage	Rental Usage	Tax Treatment
No Usage	1-365 days	Rental property
Less than 15 days	15+ days	Vacation home and rental property
More than 14 days	15+ days	Vacation home and secondary residence
15+ days	Less than 15 days	Not reportable

Can I claim any deductions for my overseas property on my US income tax return?

As mentioned earlier, everything hinges on your situation. Although the taxation and reporting of overseas rental income largely follow the same rules as those for a rental property in the US, there are a few exceptions.

If you are earning foreign rental income, you can claim the following deductions on your US tax return:

Advertising costs
Expenses for auto and travel
Cleaning and maintenance expenses
Commissions paid
Insurance costs
Legal and professional fees
The mortgage interest paid to banks or financial institutions (secured by the rental property)
Repairs
Real property taxes
Utility expenses
Depreciation expense
Other rental-specific expenses, such as condo fees or landscaping costs.

Put simply, the individual will incorporate both the income and all associated expenses, including depreciation.

Furthermore, depending on whether the individual meets the criteria for actively participating in a passive activity loss, it may further decrease their overall tax liability.

Even though my foreign rental property operates at a loss, am I still required to report it?

One crucial point to keep in mind is that reporting is not solely limited to profits. In simpler terms, even if an individual ends up with a loss due to expenses or deductions surpassing the gross income, both the income and expenses still need to be reported on Schedule E.

What does “Foreign Rental Property Depreciation” refer to?

When it comes to comparing domestic and foreign rental properties, there is a notable distinction in terms of depreciation.

Unlike domestic residential properties, which are depreciated over 27.5 years, your overseas property is depreciated over either a 30-year or 40-year duration, depending on when it was first rented.

Depreciation might be unfamiliar to some US taxpayers. Many foreign countries either don’t allow it or don’t provide significant tax benefits from it.

On the other hand, in the United States, depreciation can lead to significant tax savings, making it a valuable aspect of the tax system.

Foreign rental property depreciation involves the deduction of the declining value of a property over time. When it comes to real estate, depreciation is typically divided into two components: the land and the structure.

While land tends to appreciate and cannot be depreciated, the structure gradually decreases in value due to factors like aging or becoming outdated.

Consequently, individuals have the opportunity to depreciate the value of the structure or any improvements made over a specific period. The duration of depreciation varies based on factors such as whether the structure is residential or commercial, as well as its location.

Example:

Regarding foreign rental property depreciation, the current practice involves a depreciation period of 30 years, as opposed to the previous 40-year period before 2018.

Let’s consider a typical scenario:

Meet Sarah, who owns a rental property overseas.

The total value of the property is $600,000, with the structure valued at $300,000.

Sarah has the opportunity to depreciate the $300,000 value of the structure over a span of 30 years, resulting in an annual depreciation of $10,000.

If Sarah earns $25,000 in foreign rental income per year and has $15,000 in deductible expenses listed on Schedule E for the property, she would have a net income of $10,000, which would be subject to taxation.

However, when Sarah incorporates the annual depreciation of $10,000, her tax liability becomes zero, as the net income becomes zero after factoring in depreciation.

Who are we?

We understand that navigating foreign tax obligations while living in the US can be a complex maze, but fear not, because we’re here to simplify it all for you.

PTI Returns is part of CluneTech (formerly known as Taxback Group), a global organization with a workforce of over 1,500 professionals spread across 20 countries.

With our extensive 25 years of experience in international tax, our team of expert professionals will ensure your complete compliance with the tax authorities in both jurisdictions, leaving you with peace of mind.

Should you have any lingering questions, our tax experts are just a phone call away.

We are eager to help you navigate your unique tax situation. For a tailored no-obligation consultation with one of our experienced tax experts, simply click below. Your peace of mind awaits!

Check our prices for our US property income tax services (for residents and non-residents).