Form 1116 Foreign Tax Credit - High Tax Kickout for Foreign Rental Property

Forum|Forum|2 months ago
April 24, 2026
1 reply
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I have a foreign rental property and I paid foreign tax from the rental income. However, the net rental income for US tax reporting is 0 after depreciation (the foreign country doesn't allow depreciation).

When I report this foreign tax on form 1116, do I need to reclassify it to General category because of High Tax Kickout according to IRS code 1.904-4(c)

“If, after application of this paragraph (c), passive income is zero or less than zero, any taxes imposed on the passive income are considered related to the same separate category of income to which the passive income (if not reduced to zero or less than zero) would have been assigned had the income been treated as high-taxed income (general category, foreign branch category, section 951A category, or a specified separate category). For additional rules regarding losses related to passive income, see paragraph (c)(2) of this section.”

pk_

Level 15

@jingle123 , please could you tell me more about your rental income:

(a) which country is the property situated in? ( for purposes of co-ordination with any tax treaty articles/conditions)

(b) your tax-home -- is it USA or are you abroad?

(c) Do you have other foreign income --- I ask because , absent "general category" foreign source income, HTKO may or may not be of advantage --- HTKO is based on effective tax rate imposed by a foreign taxing authority.

(d) Are there other pertinent items/information to consider ?

I will circle back once I hear from you --yes ?

jingle123Author

Level 2

(a) which country is the property situated in? ( for purposes of co-ordination with any tax treaty articles/conditions)

Australia

(b) your tax-home -- is it USA or are you abroad?

USA

I don't. But my understanding is that HTKO is not optional?

(d) Are there other pertinent items/information to consider ?

No. The income difference is mostly from depreciation deduction rule. Australia does not allow depreciation deduction on rental properties (except for new constructions).

pk_

Level 15

@jingle123 , please accept my apologies for late response.

1. you are substantially correct in that the requirement to move the foreign source income and the tax thereon from "Passive" basket to "General" basket is required ( i.e. it is mostly mandatory).

2. Note that the whole aim of the FTC regime is to mitigate the effects of double taxation i.e. we require an equal amount of foreign source income that both jurisdictions tax under their own laws.

3. In your particular case, for US tax purposes on form 1116 you recognize the gross rental income ( foreign source income ) and reduce it by allowable deductions ( per US laws including depreciation) resulting in zero or negative amount. Thus your effective income on which to compute the "effective tax rate " is meaning less. So HTKO determination is not possible.

3. Another issue here is that since there is NO Foreign source income that is being doubly taxed -- so form 1116 usage becomes meaningless.

4. The problem thus reduces to you having a foreign tax burden that does not meet the "doubly taxed" qualification for eligibility of FTC.

5. You always have the option of not recognizing the depreciation and thereby have a positive "net foreign income" that is then eligible for FTC. But you still will have to recognize the basis erosion ( by allowable depreciation whether recognized or not ) when you dispose off the asset in the future.

That is my take on your situation.

Is there more I can do for you ?