Owning overseas rental property is a dream for many real estate investors. When you’re a US citizen, your income from anywhere in the world is still taxable by the US, so it’s important to understand how to report foreign rental income on your tax return.
Tax Reporting for Foreign Rentals
Reporting income from an overseas property is mostly exactly the same as reporting income from a domestic rental property. If the property is held in your name or a single-member LLC, then you report it on Schedule E (or schedule C if you are providing “substantial services“). This is by far the most common way to hold a rental property, and we recommend it for most situations, especially if you aren’t investing with other partners. If you are instead investing through a partnership, corporation, trust, etc., you will have other filing requirements for that entity (such as form 1120 or 1065).
Foreign Currency Exchange Rate
You must report all income and expenses in US dollars. The IRS doesn’t have an official exchange rate, so you are allowed to use any reasonable and valid method as long as you use it consistently. One option is to use the yearly average exchange rate.
Depreciation
Foreign rentals are mostly reported in the same way domestic rentals are, but depreciation is one major exception. The building portion of the cost of a domestic rental property is generally depreciated over 27.5 years (or 39 years for short term rentals). But foreign rental properties must instead use the “alternative depreciation system”. This is defined in IRC code section 168(g), which specifies a depreciation period of 30 years (or 40 years for short term rentals because they are “nonresidential”).
Foreign rental properties that were put into service and depreciated starting prior to the 2017 “Tax Cuts and Jobs Act” use a 40 year depreciation period.
1031 Exchange
Real estate located in a foreign country is not eligible for exchanging in a 1031 exchange with property located in the U.S.
Foreign Taxes
Foreign property taxes can be deducted as an expense, just as you can with domestic property taxes.
If you have to pay foreign income tax on your rental income, that isn’t something you can list as an expense for your rental as you do with the property taxes. But you can generally use the Foreign Tax Credit so that you don’t have to also pay US income tax again on that same income. But the Foreign Tax Credit can’t exceed the amount of US tax that you pay on that rental income. That means that if your rental property is operating at a loss for US tax purposes, then you won’t be able to deduct any foreign income tax that you may have to pay on the rental income.
Special Form Requirements
You may have one or more extra form filing requirements, depending on the specifics of your foreign rental property and how it is owned and financed.
- Form 8858 is probably required for owners of foreign rental properties because the rental property could fall under the definition of a “foreign branch” of your personal business activities. Even in situations where it is unclear if it is required, the safe choice is to file the form. This is a new requirement that began in 2019.
- If you have a foreign bank account at all, be sure to complete Part III of Schedule B, which asks some simple yes/no questions about your foreign account holdings.
- If you have foreign bank accounts that combined hold more than the US dollars equivalent of $10,000 at any time during the tax year, you must file the “FBAR” (form 114). Penalties for not filing this form are extremely severe (starting at a $10,000 and going up from there), so be certain to file this return if you are required to do so.
- If you hold more than $50,000 in foreign bank accounts, or if the real estate is held through a foreign entity, such as a corporation, partnership, trust or estate, then you may be required to file the FATCA form 8938.
- If the rental is held by a foreign corporation, you may also be required to file form 5471.
- If the rental is held by a foreign partnership, you may also be required to file form 8865.
- If you transfer the property to or from a foreign trust, or if you received the property as an inheritance or a gift, you may need to file form 3520 or 3520-A.
- If you sell the property to a foreign corporation, you may need to file form 926.
