Gross income on foreign rental property Form 1116

[realmccoy55]

@jtax 

Yes, I have definitely seen your extensive points on this subject, along with explanations of your reasoning, which I really appreciate. You also made if very clear that that's just your opinion until someone shows you some evidence to the contrary, but that you could be wrong. I've also read several other opposing opinions with some reasoning as well, but all based on some derived logic rather than facts or evidence. There was also one person claiming his CPA also left depreciation out, but no explanation as to why was provided. Then I came across this thread and was struck by @MarilynG1 super clear answer presented as a fact that foreign rental property depreciation was to be excluded from "definitely related" expenses on form 1116 (passive category). I was just looking to understand the reasoning for this. Perhaps there's another discussion I haven't found where this is explained, in which case if anyone could point me in that direction, that'd be greatly appreciated.

It just seems almost unbelievable that a normal person would not be able to find a clear answer with a definitive justification (ideally linking it back to some IRS form or instruction) to such a simple question and a situation that millions of people must be in with foreign rentals and US tax filing obligations. TurboTax is surely of no help, but neither is the rest of the internet...everyone everywhere always talks about gross rents and all kinds of "definitely related" expenses, but always avoiding addressing whether depreciation is or is not included. I wonder why that is...seems almost suspicious.  Maybe I'm not looking in the right way, or in the right places.... Any pointers would be welcomed.

[jtax]

Check the regulation I cited. Legal tax research order of importance starts with the statute (the Internal Revenue Code, Title 26 of the US Code), then the regulations, then court cases, and then non-binding IRS guidance of various sorts (publications, instructions, etc.). That regulation is binding authority.

There rules about how much and what type of authority is needed when a taxpayer or professional takes a tax position. The professional has a higher standard to meet. See, e.g. https://frostbrowntodd.com/a-taxpayers-consumer-guide-to-substantial-authority-tax-opinions/

If you take the depreciation deduction on the Schedule E for the property I don't see how you can't take it on the 1116. If you leave it off the Schedule E, then I think you have an argument. But your US basis upon sale is still reduced by depreciation taken or allowable, resulting in a larger US gain without the benefit of the deduction on Schedule E. I believe that is in I.R.C. 1016(a)(2) - https://www.law.cornell.edu/uscode/text/26/1016 ... perhaps a larger US gain upon sale won't matter because US capital gains tax rates are so low (sometimes 0%) and foreign rates are usually much higher. This might especially be true if the FTC wipes out any benefit of the US Sch E depreciation deduction.

I leave it to you to research whether or not one is required to take a deduction or not. Last time I reviewed that there was decent authority that a deduction that is "allowed" (typical statutory language) is not mandatory. But it's not certain, I think. However I feel (without being able to cite authority) that you would need to be consistent between schedule E and part I, 1116. Not sure how you could justify taking the deduction on Schedule E and not including it on Part I, 1116.

I do think you overestimate the number of people with foreign-rental properties. And the ability of the IRS to police this. There is no information form for that line to match against and very few people (relative to the 160  million tax returns filed a year) are in this position. I doubt they are expending resources to chase this down. That isn't relevant to your tax obligation, but may explain what is going on from a systems POV.

[realmccoy55]

@MarilynG1 

Hi, since I didn't get a reply from you the first time I asked, let me try again: can you tell me why you are saying to exclude foreign rental property depreciation from "definitely related" expenses for the purpose of Form 1116, Part I, line 2? Thanks in advance.

[jtax]

Not only what is the authority for that statement, but also why the foreign government tax calculation deduction amount should be used. Makes no sense to me.

The 1116 Part I calculation has nothing to do with foreign government tax calculations. It has to do with US income tax calculations for US income from foreign sources (IRC 862) in order to compute the I.R.C. 904 limitation on the FTC, i.e. US tax times [foreign sourced income per the IRC/treaties] / worldwide income]