Foreign Rental Property and Depreciation

[pjs]

We have rental property abroad and are paying income tax for the rental income to the foreign country. We can claim foreign tax credit for that so all good there. However, I am required to also depreciate the rental property over 40 years. Let's say I have $5000 rental income and $500 expenses to deduct. Let's also say I will make $1500 depreciation per year - I will then end up with $3000($5000-$500-$1500) rental profit on paper.

I have already paid the income taxes to foreign country so reducing the rental income in US taxation does not help me. However, when I sell the property I will be taxed more as I made depreciations on it. Doesn't sound right?

What is the right way of reporting this so that I can carry forward the depreciation benefit or otherwise make it "fair"?

[Coleen3]

Unfortunately, no. The IRS requires that you take depreciation each year. If you choose not to, you will still have to recapture at sale time.

[pjs]

Passive losses should carryover for next years. What happens if I'm living abroad and all my US taxes are offset my foreign tax credits? I wouldn't have any taxes to pay so therefore lowering the rental income would not bring me any benefit. Can I use foreign tax deduction (instead of foreign tax credit) to offset the rental income to 0 and this way the depreciation would become passive loss and would carry over to next years until I sell the property?

[Coleen3]

Taking a deduction on Schedule A will not reduce income on Schedule E. If you have a passive loss, it is because your rental expenses are higher than your rental income and your AGI doesn't allow you to take the loss each year. Your AGI is computed before the Sch A deduction.

[pjs]

In this case my AGI would be zero outside of the rental income (due to Foreign Earned Income Exclusion) and all income taxes for the rental income would have been paid to the foreign country. Reducing the rental income by the yearly depreciation in my US taxation will not help me in any way but would cost me when selling the property as depreciation recapture would occur. This is pretty common situation for Americans moving out of the country. There must be a way of accounting for this imaginary depreciation taxation, otherwise people would be paying extra tax for the full amount of property after 40 years. I don't believe this would be the case.

[Coleen3]

Actually, that is the case. If you depreciate your property completely, you have a zero basis and your entire gain is taxable as oridinary income.

[pjs]

Can I choose not to claim depreciation and use form 3115 to claim catch up depreciation if/when I sell the property for the years I have not claimed depreciation?

[Coleen3]

Yes.

[pjs]

Okay, thank you. I think that would do the trick then. Does it matter if I claim depreciation, let's say, in years 1 and 2 but not in years 3-15? Can I still use form 3115 for years 3-15 even if I have used permissible depreciation method for years 1 and 2? I guess it would not matter as I would be using 3115 only to correct years 3-15

[adamscott]

So did you figure anything out ?  I've got the same situation.  Deducting something to offset 0 taxes.  Then forced to pay recapture on large false gains.  Looking for answers. Thanks

[DaveF1006]

@adamscott Regardless on whether or not you have rental income, you should take depreciation regardless. Remember that depreciation is part of a passive loss that can reduce your AGI during the year so it does have some benefit in that respect.

in the end, the depreciation that has accumulated needs to be recaptured regardless of false gains. There is no solution otherwise.