Selling International Real Estate and Capital Gains

[DABU]

Good evening,

We own real estate (land) in India and sold one of them. There is Long Term Capital Gains (LTCG).  I have a few questions:

1. The tax system in India allows adjusting cost of acquisition/purchase price by indexation (adjusting by using cost inflation index [CII]) published by the government annually. You are also allowed to choose/opt for "without or no indexation."  But, US doesn't allow indexation.  My question is: for computing LTCG can I do indexation in India and consider the original cost of acquisition as allowed by the US tax system? Indexation helps to reduce LTCG in India. 
2. The tax system in India allows sellers to use original cost of acquisition/purchase price (which we have; for e.g., $100/sq ft) or fair market value (FMV; for e.g., $1,000 sq/ft) provided by a government approved valuator. FMV is widely used for computing LTCG in India because the government shifted CII base year from 1981 to 2001 for computing capital gains. My question is: can I use FMV in US as cost of acquisition? In most of the cases, using FMV along with indexation reduces LTCG in India.

The US and India have Double Tax Avoidance Agreement (DTAA). So, we get credit for foreign taxes paid in India on our federal tax return but not on the state tax return. Thanks for your help. Dabu. 

[pk · Accepted solution]

@DABU , yes you are correct in that India uses an indexing of the basis for purposes of  computing  gain of an asset

(a) In your particular case, it is best that you complete the  Indian tax filing first and settle that  before you do the  US tax return.  The reason for this is to avoid having to amend the US return if Indian IT   dept. changes  the tax liability --- I am aware that a 20% of the computed gain is the tax and is collected  at source.  Also there is the issue of Tax year difference  between India   ( Apr. 1st through 31st. March  next calendar year ) and the USA ( Calendar year).

(b) For US purposes  there  is no indexation applied to the basis.  Basis is defined as  Acquisition cost plus cost of any improvements.  The only time FMV is used as the cost basis is in case of acquisition by inheritance and it is the  FMV at the time of  death of the decedent or soon thereafter.  I am assuming here that you acquired the property by purchase.  Note that you will have to use the exchange  rate at the time of each transaction.  Thus if you bought the property in 1980, then you use the actual exchange rate ( from bank / published by RBI/ US Treasury  ) at that time.  Ditto for any improvements .

(c)For US purposes ,  the use of the asset  while being held by you is germane --- so if you had some income  from the asset during the period held, this should have been recognized on your US return and any allowable depreciation/ depletion ( not valid for land of course unless there is extraction of valuables like gas, oil, rocks, mining etc. ) reduces the basis , increases the gain and is subject to recapture ( taxed as ordinary income ).

(d) Also note that the gain that is treated as Capital gain will be taxed by the US under its rules/laws ( unless limited by  tax treaty )

(e) Assuming you choose to take advantage of foreign tax credit, when filling out the form 1116, you need to be sure to answer the questions carefully because the foreign gain most likely will be different  than the US gain and this creates a conundrum as to the  definition of the foreign income/gain.

Is there more I can do for you ?

Namaste

pk

[Opus 17 · Accepted solution]

If you are a US person and subject to US tax laws (i.e. a citizen, permanent resident with a green card, or resident alien) then your US tax is determined using only US tax laws, and this includes capital gains tax. You must determine your US capital gains under US law, even though you will determine your capital gains for India taxation using Indian laws.  You can then claim a credit or deduction on your US tax return for foreign taxes paid on the same income.  

Your cost basis will be your actual purchase price converted to US dollars using the exchange rate for that day (you can get historical rates online). You can adjust your basis for the cost of improvements (also at the appropriate exchange rate for when the improvements were paid for).  Also be aware that if the home was used as a rental or in business, you must make an adjustment for depreciation you claimed or could have claimed under US tax law.  

[DABU]

Good morning,

Thanks to pk and Opus for your comments and suggestions. 

1. I have been using the US Treasury Reporting Rates. I am posting the links so that they could be useful to other members. I use the dollar to rupee year-end conversion rate for each year and mention in our tax return that the currency conversion is based on the US Treasury Reporting Rates.

• You can find Treasury Reporting Rates of Exchange for the years 1963-2005 at the below link for Govinfo. These are in PDF format only. https://go.usa.gov/xm7a3                                                                        
• Treasury Reporting Rates of Exchange for the years 2001 to the present are available through the Bureau of the Fiscal Service. These datasets can be downloaded as CSV, JSON, or XML.

https://fiscaldata.treasury.gov/datasets/treasury-repor[product key removed]nge/treasury-reporting-r...

1. Is it Ok to add the following items to our cost of acquisition/purchase price?

1) attorney's fee for preparing the documentation 2) valuation fee 3) airfare for traveling to execute the transaction 4) broker commission 5) improvement charges (fencing to secure the property) 6) fee paid to the tax preparer 7) registration fee paid to the government at the time of purchase. I will have documentation to support each item. 

After adding all the fees mentioned above, the cost of acquisition will be computed and will be used on our US tax return. 

One request to pk: Is it possible to contact you outside the forum? It looks like you are an expert on the tax laws of India. This is because you clearly mention the tax rates on LTCG and taxation year in India in your reply. Please let me know. Sincerely, Dabu. 

[pk]

@DABU , as you can see there are quite a few  "experts " in this forum for answers to issues that are of general interest.  If you need more specific discussion, that may or may not of help to others, you are very welcome to PM ( the envelope icon on the top right).   Note however, that while many/most of us volunteers , are either very well versed in the  tax laws or are retired tax professionals, we are not acting in a professional capacity i.e. our advice/suggestions  are  ONLY that  and should not relied on for purposes of asserting a position to the IRS.  You do have to do your own reading ( we will of course help where to find the material ) and take up your own defense.  Having said that, however, you are most welcome to contact me though PM --- just please do limit your PII ( Personally identifiable Information) -- because  I have no idea  as to whom is privy to the content ( not the general poster or other users) beyond you and I. 

Namaste

pk

[Opus 17]

@DABU 

I don’t believe you can use an annual exchange rate. At least, the income from the sale should be recognized at the exchange rate on the date of the sale. If you are not convinced, I will try and find the actual regulation for you.  @pk may also have experience here.

Allowable additions to your cost basis are listed on page 8 of IRS publication 523.

https://www.irs.gov/pub/irs-pdf/p523.pdf

Improvements are always allowed, as are the broker’s commission. Note that an improvement is something that is attached to the real property — the land itself or the buildings attached to the land — and must either increase the value of the property or make the property better, or extend the property‘s useful lifespan. Since a perimeter fence is attached to the real property, that is include a bowl.  I don’t believe you can include your travel expenses. Some of the government transaction fees and taxes are probably allowable, but you should refer to publication 523.

[Opus 17]

@DABU 

Note that although both these pages refer to the annual currency exchange rate, both pages also say the transactions must be recognized using the exchange rate on the date of the transaction.

https://www.irs.gov/individuals/international-taxpayers/yearly-average-currency-exchange-rates

https://www.irs.gov/individuals/international-taxpayers/foreign-currency-and-currency-exchange-rates

Note that the IRS will generally accept any currency conversion rate that is “reasonable“. If the exchange rate fluctuates during the year so that reporting using the average rate gives you significantly less US income than reporting the daily rate, the IRS may not view the annual rate as reasonable in your situation.  

[DABU]

Thanks Opus for your detailed reply. I will use the prevailing exchange rate on the day of the sale and for other activities. With regard to travel expenses, I came across the following link while doing a Google search. It is an old article and was published in Bankrate.  It indicates that the travel expenses can be included.  

https://www.bankrate.com/finance/taxes/selling-property-in-a-foreign-country.aspx

We have to pay any real estate taxes owed up through the day before the sale date.  It is allowed as per publication # 523. Feel free to provide your comments and suggestions. With gratitude, Dabu. 

[Opus 17]

@DABU 

Travel expenses would be deductible on schedule E if this was a rental property and you were reporting rental income. I’m not convinced that travel expenses are an allowable adjustment to basis when selling a personal asset. Publication 551 discusses adjustments to basis in more detail.

https://www.irs.gov/pub/irs-pdf/p551.pdf

Proerty taxes are deductible as schedule A itemized deductions, not as an adjustment to basis on the capital gain that you will report on schedule D.  You can always deduct property taxes you pay on any property that you own, even if it is not your main residence. However, the deduction for all of your state and local taxes —including state income tax and property tax—is capped at $10,000 for tax year 2018 through 2025.  If you already have paid more than $10,000 of state and local property tax in the US, you will gain no additional tax deduction from the property taxes on your home in India.  Additionally, you must have enough itemized tax deductions to benefit from itemizing rather than using the standard deduction.

[DABU]

Thanks, Opus for your reply. Our transaction in India could be considered as selling a "vacant residential lot" similar to the USA.  My question is, are there are any IRS publications where they list what kind of expenses could be considered for a vacant residential lot in addition to the cost of purchase/acquisition?

I should have made it clear when I started the thread. My sincere apologies. It came to my mind yesterday night that our transaction in India fits someone in the USA selling a vacant residential lot in a neighborhood or in a development or in a community. The land in India is already zoned for single-family or multi-unit residential use and we kept it vacant. Please provide your suggestions and comments. Thanks for your help. Regards, Dabu. 

[Opus 17]

Your travel costs are not deductible, as this was personal property and not business property.

https://ttlc.intuit.com/community/investments-and-rental-properties/discussion/can-i-deduct-travel-e...

[jjayarama]

My situation is that a property I inherited in India was sold a few days prior to 6 months from the date of the owner's demise.  For calculating the cost basis, since the rules in India allow only indexing from FMV in 2001 whereas US rules allow FMV on the date of death, the cost basis is going to be much higher for the US.  I was fretting over this conundrum as pointed out by PK but the reply by Opus 17, that US rules apply for US returns, appears to make sense.  However, does anyone know if the gain in this case would be ST or LT in the US?  In India, any gain in inheritance would be automatically considered LT.  Also, can the FMV be equal to the sale value if the sale happens within 6 months from the date of demise, for the US return? Can I use this as a justification to not get an appraisal on the date of demise or is an appraisal absolutely necessary?

Using the SRO guidance values in India (which is the minimum price that is allowed for registration of that property; hence, well below FMV), and using the foreign tax credit, turbotax is calculating a US tax amount which is only about 10% less than if the foreign tax credit was not claimed.  Of course, in this case, the gain was treated as a ST gain.  Now, my understanding is that the foreign tax credit is a dollar-for-dollar credit and, in this case, it is not even remotely so.  May be I am making the entries wrong?

Any comments?

[pk]

@jjayarama ,  as I understand your situation  1. you inherited a property in India   with a then FMV of  XXXX US$ equivalend.  Subsequently you sold the property  within six months  for actual  YYYYUS$ equivalent.  India's tax based basis indexing and sold price  is IIIIUS$ equivalent.  Yes ?

(a) Because this is within such a short time since the demise of the decedent ( especially in India ), one could reasonably substitute the sales figure as the FMV  for six moth earlier.  

(b) This would imply that for US tax purposes there is probably a small loss  on expenses for  preparation for sale, sales commission, transfer tax , currency fluctuation etc. 

(c) Thus your foreign income is a small longterm capital loss.

(d) In this scenario, the foreign tax credit ( recognized dollar for dollar ) allowed for the current year would be zero because  it is based on a  ratio of foreign income to world income  based total tax allocation.

If on the other hand you want to apply the US rules as intended for US situations, then you have to get an appraisal  for the property as of the date of demise of the decedent as your BASIS  and then follow through as above.  Knowing India as I do, I don't believe you will see that much of a difference in the FMV in six months  barring special situations ( mostly because  deal making especially landed property in India takes a very longtime and there is very little speculation -- the buyer knows the potential very well .

 I have personally dealt with similar situations in Mexico and six months no make no diff.

pk

[jjayarama]

Thank you, PK.  That was very helpful.  Appreciate it.