Before making an overseas real estate investment, it is important to understand what the total cost of the purchase will be, both immediately and in the long term, including your tax liability.
Transfer taxes, for example, can be considerably higher than in the United States.
On the flip side, one of the great benefits of diversifying into overseas real estate markets can be a much lower property tax than you would incur if you make a similar investment in the United States.
Here are four potential tax expenditures to factor into your round-trip costs of a foreign real estate purchase.
1. Transfer tax
Transaction costs when buying real estate in the United States are nominal and relate primarily to financing. Foreign transfer taxes can vary from 1% to 10%. Include them in your purchasing budget. If you have $ 100,000 to invest and are buying in a market with 10% transfer tax, you are looking for a property that sells for $ 90,000 or less.
A true transfer tax is not recoverable. However, some countries – Nicaragua, for example – charge the seller a tax at the time of closing which is sometimes referred to as a transfer tax, but is actually a withholding tax on capital gains. Although these fees are billed to the seller, they usually pass them on to the buyer.
When charged, these fees are a way for the country to ensure that it receives at least part of the income tax due on capital gains from the eventual resale of a property. Governments of countries with active foreign real estate markets understand that most foreign buyers will not file a tax return when they sell real estate in that country. The tax charged at the point of sale is intended to defer any tax due on any potential capital gain. If the withholding tax is more than the capital gains tax would be (it usually won’t), you can file a tax return to try and get a refund of the difference.
Thanks to transfer taxes, buying and returning for a quick profit is not common in most foreign markets. While you can buy real estate in the United States with a high mortgage, do a little homework, then turn around and sell the property for, say, a 10% profit on your purchase price, which equates to a 100% profit on your 5% deposit after paying the real estate agent, this is not a viable strategy in most countries overseas, especially with LTV financing high is not easy to obtain as a foreigner.
2. Income tax
An important tax consideration when investing in rental property in another country is that many jurisdictions treat rental income as ordinary income for tax purposes.
Typically, you will need to file an in-country income tax return at the end of each year to report your rental income and show tax due. Some countries, however, have understood that foreign landlords do not always report rental income. This has led some countries to impose taxes on rental income at source.
Concretely, this means that in some places your property / rental manager will hold a certain percentage of the rental income you earn and remit it to the government tax office. These withholding rates are usually onerous, in an effort to motivate you to file a complete and proper tax return at the end of the year, hopefully to recover some of the withholding as a refund.
Some governments have gone so far as to proactively presume that any non-primary residence is a rental and then charge you tax on a deemed rental value / income for your property. Spain does this. So many foreign landlords only use their coastal condos and villas in this country part-time and rent them out otherwise, the government wants to be sure that it gets a share of all rental income generated in its jurisdiction.
The flaw in this approach is obvious. Not all non-primary residences are rental and not all non-primary residences are rented full time.
Most countries allow you to deduct direct and related expenses from your rental income, including mortgage interest, management fees, utilities if you pay them (this would be the case for short-term rentals, for example). example), and all other direct expenses. . What most countries don’t allow you to deduct is depreciation. This is a US accounting phenomenon that is also allowed for US tax calculations, but generally not elsewhere.
If you are a US citizen with rental property in another country, it is treated more or less the same as a US rental property for US tax purposes. You are entitled to the same expense deductions, including depreciation (although you should use a 40-year schedule for non-U.S. Property) and travel expenses to visit and verify the property. You report rental income on a Schedule E, just as you would for rental income in the United States.
Complications for an American can arise from tax liability in the country where the property is located. Without depreciation as an expense, you could have a profit in the foreign country and a loss on your US taxes. The tax you pay in the foreign country can be used as a tax credit against the tax owed to Uncle Sam for the same income. If you have no net income in the United States, due to depreciation expense, you must carry forward the tax credit. Eventually, you might be able to use it. Note, however, that if you are an American owning foreign property in your own name, this is really the only difference to your US tax reporting requirements.
3. Property tax
Not all countries impose property tax, and in those that do, the amount owed is much less than what you are likely paying in the United States.
In Belize, for example, your annual property tax on a $ 100,000 property could be $ 10. It will cost you more in gasoline to get to the government office to pay the tax than the tax amount. Fortunately, Belize allows you to pay years in advance. Keep your receipt in case your prepayment record is lost. This is Belize.
Property taxes in many countries are administered at the local level, by the municipality, which oversees collections and sometimes sets rates. This means that, depending on the country, you may need to know exactly where you will be buying before knowing what your property tax rates might be.
Sometimes a country exempts certain types of properties or certain types of purchases from property tax during certain periods, in order to encourage investment. This has been the case in Panama for the past two decades, when the government offered a 20-year tax exemption for all new property purchases, although this exemption is no longer available on new properties. You can, however, assume the remaining property tax exemption on a resale property.
In many Latin American countries, including Panama and Colombia, property taxes are paid quarterly. In Colombia, you will receive your property tax bill by post. In Panama, you won’t. You will need to go (or send your driver, for example) to the property tax office to review the bill and pay it. Colombia has an online payment option, but you’ll need a local bank account to take advantage of it.
France imposes two taxes linked to property: the property tax and the housing tax. The first is the property tax itself. The second is a housing tax. You will pay both if you rent out your property for the short term. However, if you are renting long-term furnished or unfurnished, your tenant is expected to pay the housing tax if they live in the apartment on January 1 of that tax year.
4. Capital gains tax
Not all countries impose capital gains tax on profits from real estate. New Zealand, for example, does not tax capital gains at all, not on real estate or anything else.
In France, the tax on real estate capital gains is reduced for non-residents by 6% per year from the sixth year of ownership. You have been a homeowner for 22 years or more and you owe no capital gains tax.
It’s France, so that’s not the end of the story. You are also liable for a social security charge on the gain which decreases each year after the fifth year of ownership and reaches 0 after 30 years. Sell within five years, and you’ll owe 19% capital gains tax and 7.5% payroll taxes.
Of course, Americans are liable for capital gains tax in the United States on profits when selling goods abroad, even though no capital gains tax is. collected in the foreign country. However, you get a tax credit for any capital gains tax paid in the country where the property is located. If the tax owed is higher in the foreign country than in the United States, you do not owe anything on the American side. If the tax due in the foreign market is less than the US tax, you pay the difference on the US side.
Speak to your U.S. tax preparer for details on how these foreign tax credits work. Ultimately, you shouldn’t be paying more tax on capital gains than the highest applicable tax rate. For example, if you are taxed at 10% on your gain in the foreign country and fall into the 15% capital gains tax rate in the United States, you owe the IRS the 5% difference. . Certain deductions are allowed when calculating the gain.
Although not all countries impose capital gains tax on real estate, most of them impose a special rate for capital gains. A few, however, tax capital gains as ordinary income.
Some countries apply an inflation rate to adjust the gain calculation so that it is based on a present value of the original purchase price, and some have exemption amounts that reduce taxable gains.