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Get your taxes done using TurboTax
Yes, it is possible to mix and match your foreign taxes. IRS Publication 514 says you must choose to take a credit or a deduction for all foreign taxes you pay in a year. However, you can mix them if specific taxes aren't eligible for the credit. You cannot take a credit and a deduction for the same tax.
Since you have the TurboTax software, go to your forms mode and select Schedule A. Go to line 6 and enter "Foreign Income Taxes on income not creditable due to U.S. loss." and then the amount. This will now become an itemized deduction."
The basis for this is found under "Exceptions for foreign taxes not allowed as a credit." It identifies Section 901(m) as the legal anchor for your situation. The text specifically states:"You paid or accrued taxes on income or gain in connection with a covered asset acquisition. Covered asset acquisitions include certain acquisitions that result in a stepped-up basis for U.S. tax purposes"
For the IRS, a "Covered Asset Acquisition" (CAA) is a technical term for a transaction where the U.S. and a foreign country disagree on the value (basis) of an asset.
- The Basis Step-Up: When you inherited the home, the U.S. gave you a "stepped-up basis" to its Fair Market Value ($150,000) under Section 1014.
- The Foreign Disparity: The foreign country likely ignored this death-time reset and calculated your tax based on a much lower "carryover basis" (what your father originally paid).
- The "Disqualified" Portion: Section 901(m) says that because the foreign country is taxing "income" that the U.S. doesn't even recognize (the difference between your $50k sale and the $150k basis), that portion of the tax is disallowed as a credit.
The Resulting Deduction: Because the tax is "not allowed as a credit" under this specific rule, Pub 514 grants you the exception to deduct it on Schedule A, even if you are taking the credit for other things, like your dividends.
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