Selling a Home Outside the United States: How the Gain Is Taxed in the U.S.

The principal residence exclusion applies abroad

Section 121 allows an individual to exclude up to $250,000 of gain — $500,000 for married couples filing jointly who meet the requirements — on the sale of a principal residence. Nothing in the rule limits it to U.S. property. The seller generally must have owned and used the home as a principal residence for at least two of the five years before the sale, and must not have used the exclusion on another sale in the prior two years. Partial exclusions can be available where a sale is due to a change in employment, health or certain unforeseen circumstances.

Gain is measured in dollars

For U.S. purposes, the purchase price is converted to dollars at the exchange rate on the purchase date, improvements at the rates when they were made, and the sale price at the rate on the sale date. The resulting dollar gain may be larger or smaller than the local-currency gain. A home bought for 5 million pesos and sold for 5 million pesos shows no local gain, but if the peso strengthened against the dollar during ownership, the U.S. calculation shows a gain.

The foreign mortgage problem

A mortgage denominated in a foreign currency is treated as a separate transaction for U.S. purposes. If the foreign currency weakens between the time the loan is taken and the time it is repaid, the taxpayer repays fewer dollars than were borrowed, which produces a taxable foreign currency gain under section 988. If the currency strengthens, the resulting loss on a personal-residence mortgage is generally not deductible. The mortgage gain is separate from the home sale and is not covered by the section 121 exclusion.

Foreign tax credits

Foreign tax paid on the sale can generally be claimed as a foreign tax credit against U.S. tax on the same income, subject to the limitation rules. Where the home country exempts the sale, there is no credit available and the U.S. gain above the exclusion is taxed at U.S. rates. Where the home country taxes the sale at a higher rate, excess credits may be carried back one year or forward ten years in the same category.

When part of the home was rented

If the home was rented out for part of the ownership period, depreciation allowed or allowable after May 6, 1997 cannot be excluded and is generally taxed at up to 25 percent. Periods of nonqualified use after 2008 can also reduce the exclusion. Many Americans abroad who rent out their former home after moving must also consider whether the two-of-five-year test is still met at the time of sale.

Reporting the sale

• Form 8949 and Schedule D for the sale, even when the full gain is excluded if a Form 1099-S or equivalent is involved or if any gain is taxable
• Form 1116 for any foreign tax credit claimed
• Reporting of foreign currency gain on the mortgage as ordinary income where applicable
• FBAR and Form 8938 reporting for foreign bank accounts holding the proceeds

Planning considerations

• Keep records of purchase price, improvements and dates in the original currency
• Evaluate the timing of a sale relative to the two-of-five-year test after moving
• Consider the currency of any refinance and the impact of repayment
• Coordinate with the local tax result, especially where the home country offers its own exemption

Sources and official references

• IRS — Publication 523, Selling Your Home
• IRS — Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad
• IRS — Foreign currency and currency exchange rates
• IRS — Publication 514, Foreign Tax Credit for Individuals