Hi, I am going to be selling a residential apartment property in another country and it has been held for over 15 yrs.

[goyal_raj]

Hi,
I am going to be selling a residential apartment investment property in another country and it has been held for over 15 yrs. There are two scenarios:
1. I would pay taxes on the capital gains in that foreign country with which USA has double tax treaty, so I should get credit for the taxes paid there. In this case I would have to declare the capital gains and  would have to pay the long term capital gains tax (for Federal return) and adjust for the difference based on taxes paid in the foreign country. How would the state tax be calculated for North Carolina? Would I get credit for the taxes paid in the foreign country? Would the taxes be base don a preferential rate since this is a long term gain?
2. I may choose to invest in some specific bonds in that foreign country and that would make my gains tax free as per the tax laws there. How would the gains be treated in USA?

Thanks,
RG

[DaveF1006]

Yes, if you sell your property and pay taxes in the country, you may apply for a Foreign Tax credit in Turbo Tax to apply a credit against the taxes already paid. Keep in mine the Foreign Tax Credit is a non-refundable credit which reduces your tax liability to zero. If you tax liability is reduced to zero, the unused credit can  carry back for one year and then carry forward for 10 years the unused foreign tax credit.

For the state return in North Carolina, there is no foreign tax credit that can be applied. Foreign tax credit is strictly federal. if you invest in bonds and if you pay taxes, you can apply the foreign tax credit the same as above. Your gains aren't tax free however and are taxed the same as domestic bonds. You will be able to claim the long term capital gain rate on your return if you are entitled to it.

As far as adjusting the difference paid in taxes, you will not do that on your own. The Foreign Tax Credit does that for you. 

[goyal_raj]

Thanks DaveF1006.

If North Carolina state does not give me foreign tax credit then does that mean that the entire capital gains would be taxed again in North Carolina despite me having paid tax on it in another country? If yes, would it be like ordinary income or at a long term gains tax rate?

For scenario 2, by investing in Bonds, I meant that I would invest all my capital gains in Infrastructure bonds in that country for 5 yrs and that would make my capital gains tax free (income on bonds would be taxable) as per the tax laws in that country. How would IRS and NC state treat my gains in that case?

Thanks again,

[Vanessa A]

Q. If North Carolina state does not give me foreign tax credit then does that mean that the entire capital gains would be taxed again in North Carolina despite me having paid tax on it in another country

    Yes and No.  All income you receive when living in the US is taxed by multiple government entities (Federal, State and Local).  When you receive the credit for foreign taxes paid by the federal, you are still being taxed in the same way.  If you sold the property in another state, then you may be eligible for a state credit to offset your taxes paid to the other state, but this is comparable to the state not giving you a credit for paying federal taxes. 

Q. If yes, would it be like ordinary income or at a long term gains tax rate?

If you owned the home for 15 years, it would be a long term gain, however, NC does not have a special capital gains tax rate.  It is taxed at the same 5.25% rate of the rest of your income. 

Q. How would IRS and NC state treat my gains in that case?

You would still be taxed under US and NC rules.  Meaning, if you received the income, even if you turn around and invest it in something else, you would be taxed on that income the same as if you did not invest it in bonds. 

[goyal_raj]

Thanks for the detailed response.

One last question just so I am clear...

For Federal, my income would include the gains on sale as long term gain and the tax would be calculated accordingly and then the foreign tax paid would be given credit for.  A simplified example below:

Ordinary US Income- 100,000 (say adjusted)

Capital gains on sale of property- 100,000

Tax as per IRS- 40,000 (let say, 25000 on ordinary income and 15000 on capital gains at a preferential rate)

Tax credit for what was paid abroad- 20,000

Net Federal Tax= 40000-15000= 25,000.  (15000 because that is what the IRS calculated as tax)

IS that correct?

Now for NC state, if there is no long term gains and no credit for foreign tax paid,  for the state the income would  be 200,000 and 5.25% on it (since no tax credit or long term gains tax advantage ) would be 10,500 tax. Is that right?

Thanks again,

[Vanessa A]

Tax credit for what was paid abroad- 20,000

Net Federal Tax= 40000-15000= 25,000.  (15000 because that is what the IRS calculated as tax) IS that correct?

 If based on treaties and such, $15,000 was the credit amount calculated then yes, you would pay $25,000 to the IRS for your sale of the property and your other income. 

Now for NC state, if there is no long term gains and no credit for foreign tax paid,  for the state the income would  be 200,000 and 5.25% on it (since no tax credit or long term gains tax advantage ) would be 10,500 tax. Is that right?

Yes, that is correct. 

[goyal_raj]

Thanks Venessa.

Any reason behind not states not giving preferential rates on long term gains or even tax credit? This is like double taxation especially if i pay the full tax in a foreign country. Any way it can be avoided?

[ErnieS0]

Every state makes their own rules. Some states do treated capital gains differently but North Carolina does not.

North Carolina does allow a credit for "tax imposed by and paid to another state or country on income that is also taxed by North Carolina."

"Some foreign countries do not require individuals to file income tax returns.  Instead, their income tax liability is paid through withholding.  The Department will accept evidence of the withholding to substantiate the tax credit."

See Credit for Income Tax Paid To Another State or Country

[goyal_raj]

Thanks ErnieS0.

Since NC tax is only 5.25% while the tax in the foreign country may be 20% plus, it seems I shall get a credit for it and have to pay no tax at all in NC. Right?

Thanks a lot.

[Opus 17]

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@goyal_raj wrote:

Thanks Venessa.

Any reason behind not states not giving preferential rates on long term gains or even tax credit? This is like double taxation especially if i pay the full tax in a foreign country. Any way it can be avoided?

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First, I don't believe your US tax credit can be any more than the US tax on the income would have been.  If the foreign tax on the capital gains is $20,000 and the US tax is $15,000, the maximum foreign tax credit is $15,000. Otherwise, the foreign tax you paid on the capital gains would be reducing the US income tax on your US income.

Generally, your state will tax you on all your world-wide income, to pay for the various expenses and benefits of living in that state.  

North Carolina does appear to have a foreign tax credit.

https://www.ncdor.gov/taxes-forms/individual-income-tax/credit-income-tax-paid-another-state-or-coun...

Turbotax should include this computation, although sometimes the program does not include every state computation.  The requirement to include a receipt or other proof of payment of the foreign tax suggests you won't be able to e-file, although it may be that you can e-file first and mail the receipt separately.