Getting U.S. Tax Deductions on Foreign Real Estate

Many Americans look overseas for vacation homes, rental income properties, and places to settle down during retirement—whether that’s two or 20 years away. The tax benefits of owning property abroad are similar to those of owning in the United States, with a few exceptions.

The benefits that you get under U.S. tax law depend on how you use the overseas property. For example:

• If you live in the home, you generally can claim the mortgage interest deduction—and deduct mortgage points and private mortgage insurance (PMI).
• If you earn rental income from the property, you can deduct the “ordinary and necessary expenses for managing, conserving, and maintaining” the home. These expenses include mortgage interest, property and liability insurance, repair and maintenance costs, and local and long-distance travel expenses related to maintaining the property.

Property for Personal Use

If you use the property as a second home and not as a rental you can deduct mortgage interest, mortgage discount points, and PMI just as you would for a second home in the U.S.

For the 2022 tax year, you can deduct the interest that you pay on the first $750,000 ($375,000 if married and filing separately) of qualified mortgage debt on your first and second homes. That’s the total amount for both properties combined.

Note that if you bought your properties before Dec. 16, 2017, you receive the previous deduction limit of $1 million of qualified mortgage debt. Check with a tax expert to be sure where you fit in.

As with a primary residence, you can’t write off expenses such as utilities, maintenance, or insurance unless you’re eligible to claim the home office deduction.

While the mortgage interest deduction is the same whether the home is in the U.S. or abroad, property taxes work differently. Foreign property taxes are not deductible for tax years 2018 through 2025.

Foreign Rental Property

The tax rules are more complicated if you earn rental income on the property. Different rules apply, depending on how many days you use the home for personal rather than rental use. In general, you’ll fall into one of two categories:

1. Personal residence: You rent out the home for 14 days or fewer and use it for more than 14 days or 10% of the total days when it was rented, whichever is greater. You can rent the house to someone else for up to two weeks (14 nights) each year without having to report that income to the Internal Revenue Service (IRS). Even if you rent it out for $5,000 a night, you don’t have to report the rental income as long as you didn’t rent for more than 14 days. The house is considered a personal residence, allowing you to deduct mortgage interest under the standard second-home rules. However, you can’t deduct rental losses or expenses.
2. Rental property: You rent out the home for more than 14 days and use it for fewer than 14 days or 10% of the total days when it was rented, whichever is greater. In this case, the IRS considers the home a rental property and views the rental activities as a business. You must report all rental income to the IRS. Still, the good news is that this permits you to deduct rental expenses, such as mortgage interest, advertising expenses, insurance premiums, utilities, and property manager fees. You must allocate the expenses between rental and personal use based on the number of days when the home was used for each purpose.

Keep in mind that if a member of your family uses the house (e.g., your spouse, siblings, parents, grandparents, children, and grandchildren), it counts as a personal day unless you collect a fair rental price.

One notable difference is that foreign properties are depreciated over a 30-year period, instead of the current 27.5 years for domestic residential properties. In either case, you can depreciate the value of the building only; the land is not depreciable.

Capital Gains on Foreign Home Sales

If you sell your foreign home, the tax treatment is similar to selling a home in the U.S. If you lived in and owned the property for at least two of the last five years, it qualifies as your primary residence. You you can exclude up to $250,000 of capital gains (or up to $500,000 for married taxpayers) from the sale.

This primary-home sale exclusion does not apply if the home was not your primary residence, in which case you’ll owe the usual capital gains tax on the entire gain.

Keep in mind that the gain counts as a source of foreign income, so it will be eligible for the foreign tax credit. However, it won’t be considered foreign earned income, so you can’t claim the foreign earned income exclusion.

1031 Exchanges

If you sell your foreign property, you may be able to make a 1031 exchange (also called a like-kind exchange), in which you swap one investment property for another similar property on a tax-deferred basis. Many investors use this strategy to defer paying capital gains and depreciation recapture taxes.

However, property in the U.S. is not considered like-kind to any property overseas. U.S. Internal Revenue Code Section 1031 allows only domestic-for-domestic and foreign-for-foreign exchanges.

The U.S. considers any property outside the U.S. to be like-kind with any other similar property outside the U.S. So, it is possible to 1031 exchange a house in Panama for another in Panama—or in Ecuador or Costa Rica, for that matter. It just won’t be considered like-kind with any U.S. property. 

Tax Reporting for Foreign Property

Be aware that you may be required to file a number of U.S. tax forms, depending on your exact situation as a foreign property owner. For example, if you rent out your home abroad and open a bank account to collect rent, you must file a Report of Foreign Bank and Financial Accounts (FBAR) form if the aggregate value of all your foreign accounts is $10,000 or more “at any time during the calendar year.”

Other forms include Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations (if your property is held in a foreign corporation); and Form 8858, Information Return of U.S. Persons with Respect to Foreign Disregarded Entities and Foreign Branches (if your offshore property is held in a foreign limited liability company).

Double Taxation

If you operate your home abroad as a rental property, you may owe taxes in the country where the property is located. To prevent double taxation, you can take a tax credit on your U.S. tax return for any taxes that you paid to the foreign country relating to the net rental income.

However, there is a maximum allowable tax credit. You can’t take a credit for more than your U.S. tax on the rental income after deducting expenses.

In addition to taking a tax credit for any rental income taxes paid, you can also claim a foreign tax credit if you sell the property and pay capital gains tax in the foreign country. 

The Bottom Line

Foreign property ownership and tax laws are complicated and change from time to time. You can protect yourself by consulting with a tax accountant or a real estate attorney, or both, in the U.S. and abroad.

When you buy abroad, take extra care with the planning and details. Many countries have rules and regulations about who can own property and how it can be used.

In the U.S., homebuyers receive title to the property. This distinction is not as clear in other countries. So, if you buy a home overseas, make sure that the transaction is conducted in a manner that protects your property rights.