Treatment Mortgage and Capital Gains on sale foreign property

[Anne100]

I am potentially selling my apartment and I am wondering what the tax implications are.

The following numbers are for illustration purposes only, but I wonder if my reasoning is correct.

I bought the property in 2008 for EUR 100,000, which was worth USD 145,000 at the average 2008 EUR/USD exchange rate. I took out a mortgage at the time for EUR 80,000.

I now want to sell my property for EUR 150,000, which at current exchange rates is USD 165,000. I still have EUR 80,000 left on my mortgage.

Several questions:
Question 1:
Is it correct that I should calculate my capital gain in USD, so effectively USD 165,000 minus USD 145,000 = USD 20,000? As opposed to a capital gain of EUR 50,000 translated to USD now, which would be USD 55,000.

Question 2:
Does the mortgage have to be taken into account? i.e. I have an exchange rate gain on my mortgage, which is still EUR 80,000 but has decreased from USD 117,000 in 2008 to USD 89,000 now. Is that gain somehow off-setting the capital gain?

Question 3:
I know the depreciation of the property will need to be re-capped and is taxable at 25%. How do I figure out how much the allowable depreciation is in total on this property for the past 8 years?

[TaxGuyBill · Accepted solution]

1)  Yes, plus the tax on the depreciation.

2)  No, the mortgage does not factor into calculating the gain from the sale.

3)  Have you been renting out the property?  Have you been depreciating it with TurboTax?  TurboTax should have a "Depreciation and Amortization Worksheet" that will show the "prior depreciation" and "current depreciation".  If you have been using TurboTax the entire time, it will probably even automatically enter that number for you when you enter the sale in the Rental section.

As a side note, the depreciation is taxed at your regular tax bracket, up to 25%.  That means if you are in the 15% tax bracket, you may only pay 15% on the depreciation.  Also, don't forget State taxes.

[BobinDC]

Note:  Turbotax incorrectly calculated depreciation for foreign rental properties prior to 2014 (i.e., it used a 27.5 year life instead a 40 year life).  Most likely you took too much depreciation and will need to file with IRS for a change of depreciation method.  You may need to hire an accountant as the form is complicated.  Unfortunately, (and unconscionably) Turbotax does not support this form and will provide little assistance to you with this despite the fact that its programming bug created the problem.  

Turbotax will argue that it is not responsible because you did not enter the right inputs.  Yeah right.  Easy Step specifically asks whether the rental property is located in a foreign country and also requires the address of the property, including the country.  Even if you correctly inserted this information Turbotax would still use the wrong asset life.  So who is responsible???  Turbotax screwed me and thousands of others due to this programming bug, then took no responsibility for it.

[roger1]

Actually TaxGuyBill, your answer is incorrect.  I've been working in international taxation for over 31 years.  There are THREE gains here that need to be addressed.  First, he has a gain on the sale of the rental property.  The gain is the sales price in Euro less the cost in Euro at today's exchange rates.  Second he has an exchange gain under IRC §988 for the currency appreciation on the cost basis, calculated as cost basis at sales date rate less cost basis at purchase date rate.  Finally, he has a gain on the settlement of the mortgage, using the exchange rate at the mortgage origination less the payoff at the payoff date exchange rate.

Hope this helps!

[BobinDC]

Roger,  three questions:

(1) Suppose the mortgage was paid down through past monthly payments.  How does that affect the calculation of exchange rate gain or loss?

(2) Suppose the mortgage was refinance one or more times before the property sale?  How does that affect the calculation?

(3) Suppose the mortgage is refinanced for more than the unpaid balance,. i.e., there was cash paid out to the borrower.  How does that affect the calculation?

(4) Lastly, where is the exchange rate capital gain or loss on the payoff entered on the tax return?  Schedule D?

[BobinDC]

Sorry, those were four questions.  

[paulreese18]

Dear sir,

I will appreciate your answer on my scenario.
I bought a Canadian property at $441k Cdn out of which we assume the land cost is 151k

It was my principal residence for 7 years, and I was renting out 20% (2 rooms) and living in the rest of the space.

I moved to the US and rented it out 100% for the past 3 years 

I have never claimed depreciation and am trying to catch up by filling out form 3115

At the time of purchase the exchange rate was almost 1:1, over the years the Cdn currency has been going down in value. So when I claim depreciation, do I adjust the cost basis for every year per yearly average exchange rate? Canadian value remains the same but USD would be going down each year since.

[MarilynG1]

@paulreese18 You can't 'catch up' on Depreciation of Rental Property if you didn't claim it in the past.  The IRS calculates your depreciation at sale as if you had claimed it.

Enter your Rental Property as an Asset in the Rental Section, with the Cost Basis (for the 20% rental portion) at the time you started renting it (original cost plus any improvements).  When you enter your Sale Info, Prior Depreciation will be calculated for you.

You would not make any depreciation adjustments for fluctuating currency exchange rates.

Click this link for more info on Selling Foreign Rental Property.

This link gives instructions for How to Report Sale of Rental Property. 

[paulreese18]

I think you can catch up using form 3115. 

[MarilynG1]

@paulreese18 Per Champ @Anonymous_,

"There is sort of a split of opinion on this scenario with some professionals asserting that an incorrect basis can be adjusted by filing Form 3115 and others asserting the use of an incorrect basis is not an impermissible method of accounting that is subject to a 481(a) adjustment on Form 3115 (i.e., prior, open, returns can only be amended)."

Click this link for more discussion on Form 3115.

[paulreese18]

I am not adjusting the basis, I am claiming  missed depreciation using firm 3115. Even though I don’t want to depreciate but it’s added by force by IRS in democratic world where are doing an undemocratic thing that is forcing rental property owners to take depreciation and if we don’t take we loose. We loose either way.