US Tax Rules for Selling Property Overseas

U.S. citizens and resident aliens are subject to tax on their worldwide income, which includes gains from selling property located outside the United States. The location of the property does not alter the obligation to report the transaction to the Internal Revenue Service (IRS). Understanding the rules for calculating the gain, applying exclusions, and reporting the sale is necessary for meeting these obligations and avoiding penalties. This process involves specific currency conversions and filing the correct forms.

Calculating Your Taxable Gain or Loss in U.S. Dollars

To determine your U.S. tax obligation, you must calculate the gain or loss from the sale in U.S. dollars. This begins with the property’s cost basis: its original purchase price plus acquisition-related expenses like legal fees and transfer taxes. These initial costs must be converted from the foreign currency into U.S. dollars using the exchange rate on the date of purchase.

Next, you determine the property’s adjusted basis, which starts with the initial cost basis. This figure is increased by the cost of any significant capital improvements and decreased by any depreciation claimed, which is common for rental properties. Each capital improvement cost must be converted to U.S. dollars using the exchange rate on the date that cost was incurred.

The amount realized from the sale is the gross sale price minus selling expenses like real estate commissions, advertising fees, and legal fees. Both the sale price and the selling expenses must be converted to U.S. dollars using the exchange rate on the date of the sale. Using an average exchange rate for the year is not permitted.

Your capital gain or loss is the amount realized minus the adjusted basis, calculated in U.S. dollars. If you previously claimed depreciation on the property, a portion of your gain may be classified as “unrecaptured Section 1250 gain.” This gain is taxed at a maximum rate of 25%, which is higher than standard long-term capital gains rates.

Applying the Principal Residence Exclusion

The principal residence exclusion, or Section 121 exclusion, can apply to the sale of a foreign property. This provision allows an individual to exclude up to $250,000 of gain ($500,000 for married couples filing jointly) from their taxable income. The exclusion is fully available for a main home located in a foreign country.

To qualify, you must meet both an ownership test and a use test. The ownership test requires you to have owned the home for at least two of the five years before the sale. The use test requires you to have lived in the property as your principal residence for at least two of the five years before the sale. These two years do not need to be continuous.

If you do not meet the full two-year requirements, you may be eligible for a partial exclusion. This can occur if the sale was due to a change in employment, health reasons, or other unforeseen circumstances. The partial exclusion is based on the portion of the two-year period that the ownership and use tests were met.

The amount of gain eligible for the exclusion may be reduced by any period of nonqualified use after 2008, such as when the property was a vacation or rental home. This reduction is based on the period of nonqualified use and prevents excluding gain attributable to its time as an investment property.

Reporting the Property Sale on Your U.S. Tax Return

The transaction must be reported on Form 8949, Sales and Other Dispositions of Capital Assets. On this form, you detail the property description, acquisition and sale dates, sale price, and cost basis in U.S. dollars. The totals from Form 8949 are then carried over to Schedule D, Capital Gains and Losses, to calculate your net capital gain or loss. This final figure is entered on your Form 1040, distinguishing between short-term (held one year or less) and long-term gains, which are taxed at different rates.

The gain could also be subject to the 3.8% Net Investment Income Tax (NIIT). This tax applies to the lesser of your net investment income or the amount your modified adjusted gross income (MAGI) exceeds certain thresholds. For 2024, these thresholds are $200,000 for single filers and $250,000 for married filing jointly.

The rules for reporting a loss depend on the property’s use. A loss from the sale of personal-use property, such as a main home or vacation home, is not deductible. A loss on an investment or rental property is deductible, subject to capital loss limitations of up to $3,000 of net capital losses against other income each year.

Claiming the Foreign Tax Credit to Avoid Double Taxation

When you sell property in a foreign country, you often pay income tax on the gain to that country. To prevent double taxation, U.S. tax law provides a foreign tax credit. This credit reduces your U.S. income tax liability on a dollar-for-dollar basis for the foreign income taxes you paid.

The credit is only available for foreign income taxes. Other taxes paid, such as value-added taxes (VAT) or property transfer taxes, do not qualify for the credit. These non-creditable taxes can instead be treated as part of the property’s basis or as a selling expense, which reduces the total calculated gain.

To claim the foreign tax credit, you must file Form 1116, Foreign Tax Credit. The credit is limited to the amount of U.S. tax you would have otherwise paid on that foreign-source income. This limitation prevents the credit from offsetting U.S. tax on your U.S.-source income.

As an alternative to the credit, you can deduct foreign income taxes on Schedule A as an itemized deduction. Claiming the credit on Form 1116 usually provides a greater tax benefit than a deduction. A credit reduces your tax liability directly, while a deduction only reduces your taxable income.

Additional Foreign Asset Reporting Obligations

Beyond reporting the income, the transaction may trigger separate informational reporting requirements. These forms do not assess tax but are for disclosure, and failure to file can result in significant penalties, even if no tax is owed.

If the sale proceeds are held in a foreign financial account, you may need to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. This is required if the total value of your specified foreign assets exceeds certain thresholds. For a single taxpayer living abroad, the threshold is met if assets are more than $200,000 on the last day of the year or more than $300,000 at any point during the year.

A separate requirement is the FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR). You must file an FBAR if the combined value of all your foreign financial accounts exceeds $10,000 at any time during the year. This form is filed electronically with the Financial Crimes Enforcement Network (FinCEN), not the IRS, and has a different due date than your income tax return.