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 through if you plan to stay tax compliant with IRS. Here we break down exactly what is capital gains tax and how you can report them.
Capital Gains Tax Explained
Simply put, 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 subtracting 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 – Cost Basis x (Purchase Price + Any Additional Costs*) = 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.
The IRS taxable any asset that gets sold and produces a capital gain. This includes any activity inside and outside the US where capital gains are made. So if you sell your yacht in Italy for more than the original purchase price as a US expat, you’ll have a capital gain to file on your tax return.
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.
If you are interested 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.
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 owned your asset for more than one year. Most likely, your long-term tax rates will be between 0-20%, depending on your taxable income. 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. If you’re thinking about buying foreign property, don’t forget to consider the possible capital gains when you sell it in the future.
Meaning, that 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 all Americans abroad need to fill out or give 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.
Already planning for next years tax season? Here are some additional tips for how you can make filing your US expat taxes even easier in the future!