Capital gains tax for US citizens living abroad can be complex due to expat tax laws and regulations. Whether you are selling your home abroad or rental property, it’s a process you’ll need to walk for IRS. Here we breakdown exactly what is capitals gains tax and how you can report them.
Capital Gains Tax Explained
To put it simply, according to the Oxford dictionary, a capital gain is a profit from the sale of property or an investment. It is essentially, what you gain when you subtract the asset’s purchase price from the sale price. Capital gains can be recognized when the asset is sold and can be short term (one year or less) or long term (more than one year).
For example, let’s say you sell a house higher than the original sale price. To determine the capital gain, you can use this calculation:
House Sale Price + Any Additional Costs* – House Purchase Price = Capital Gain
*ie: renovation, repairs
If for example, you sell the house for less than the original purchase price, it is called a Capital Loss.
Any asset that gets sold and produces a capital gain is taxable by the IRS. This includes any activity inside and outside the US where capital gains are made. So if you are selling your yacht in Italy more than the original purchase price as a US expat, you’ll have a capital gain.
Most importantly, capital gains must be claimed when you do your US income taxes! The US taxes any and all capital gains at 0% to 20% – depending on your filing status.
Plus, if you have an interest in a Passive Foreign Investment Company, you might be subject to a higher tax rate on those gains. And, as we said in the above paragraph, this goes for capital gains on worldwide investments and assets too. This includes whether what you sold is subject to other (foreign) capital gains tax too.
Short-Term and Long-Term Gains
Did you know there are short-term and long-term capital gains?
Short-term gains are when you hold an asset (like a company stock) for a year or less before it’s sold. They will be taxed according to where your tax threshold is.
Long-term gains are the opposite – you’ve been owning your asset for more than one year old. Most likely your long-term tax rates will be between 0-20% depending on what your taxable income is. Generally, these tax rates will be lower than what short-term capital gains will be taxed on.
However, if you own foreign property as an American, you may or may not have to pay a capital gains tax.
Meaning, any capital gain on qualified home sales* over $250,000 is taxable for the US. Anything under is exempt from capital gains tax. If you sell a property you own and lived in within the past five years in the Bahamas for $270,000 (when the original price was $250,000), you’ll get a $20,000 capital gain and will not need to pay tax to the US. However, you may need to pay tax for the Bahamas (it depends on their laws).
*Qualifying home sales can be in and outside the US, however, they must fulfill the two following requirements:
In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You’re eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.
Generally, you’re not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home. Refer to Publication 523 for the complete eligibility requirements, limitations on the exclusion amount, and exceptions to the two-year rule.
If you file jointly with your spouse on qualifying home sale capital gains, the threshold exemption goes up to $500,000.
Reporting Capital Gains
If you want to skip out on our efficient online tax software, then do this: Report your capital gains on Form 8949, Schedule D and transfer everything to Form 1040 is your best bet.
Form 1040 is the annual US tax return that all Americans abroad need to fill out or give to a professional to do it for them.
But what about reporting your capital losses? They will first be used to offset or balance out your capital gains. But it would have to be offset as short-term losses against short-term gains, and long-term losses against long-term gains. Then, once you have your net loss, you can deduct it against the other type of gain.
If you have $5,000 of a short-term loss, and a $1,000 short-term gain, the short-term loss (of $5,000) can be deducted against the net long-term gain (if you have one). But if a net capital loss of the year is more prominent, you can actually deduct up to $3,000 of the loss against other forms of income (like salary). For those who are “married filing separately” can deduct their capital losses up to $1,500.
Paying Capital Gains Tax to Another Country
Americans abroad who also have to pay capital gains tax in a foreign country can use the IRS Foreign Tax Credit benefit when filing their US tax return. Therefore, you can claim $1 US tax credit for every dollar of tax you’ve paid in another country. This prevents American expats from paying twice on taxes for their capital gains.
Need Some Support?
Still struggling to understand capital gains for US citizens living abroad, or losses and everything in between? We at MyExpatTaxes can help. Our well-informed, personal staff can assist you with any expat tax questions you have.