Tax implications of sale of Inherited Foreign Real Estate

[angela94]

Re Foreign real estate Inheritance, sale and taxes.

My husband inherited an apartment located in Germany worth about $100K in 2018. At the time he paid $15K in inheritance taxes. I did not report that as foreign taxes at the time. (We are US Citizens living in US filing jointly.) 

It was soon rented and we reported that income, expenses, and related German taxes in 2018 and 2019. 

He sold the apartment this year. I don't know yet what the net profit or loss will be.

I reported a small amount of foreign divided income and foreign taxes paid on those dividends, but did not report the $15K in inheritance taxes on our 2018 return? Should I have, and if so, where? Or do I report it in the year of the sale of the property? I tried going through the amended tax return process for our 2018 taxes in Turbotax, and adding the amount to the foreign inheritance taxes paid, but it's saying I would owe more money by including the $15K paid in foreign taxes. Since the property wasn't sold in the year the the inheritance taxes were paid, there wasn't much foreign income against which to deduct the taxes.

Second question: In figuring out the net profit or loss, do I figure out USD sale price minus USD inherited value (conversion rate at the time of each individual transaction), or do Euro sale price minus Euro inherited value, and then convert to USD using the conversion rate at the time of sale? Do I deduct the inheritance tax paid in 2018 from the 2020 sales price? (with same Euro / USD question).

Thanks for any help you can offer.

[pk · Accepted solution]

@angela94 , in your case as reported in your post, my opinion is as follows:

1. Inherited a property  in 2018 with a Fair Market Value of US$100,000  ( at the then exchange rate ) along with a local tax of  US$ 15,000.  Hence the net basis of the property received is US$85,000 -- all using the exchange rate at the time.

2. The property was used as income property for the years 2018 and 2019 --- On schedule E  you therefore declared/recognized the gross income, allowable expenses , real-estate taxes etc., and depreciation.  This reporting is done without regard to German tax laws i.e. US filings stand on their own independent of the effects of the German laws  and if you paid any taxes on the rental income then that is generally recognize as foreign  income tax.

3. When  the property is sold, reporting of that is based again on US laws ( for the purposes of gain computation). You use the  exchange rate on the day of consummation/closing of the sale or the date the monies were made available to you. Note that the gain computation for US purposes is selling price Less sales expenses including transfer tax etc.  LESS your adjusted basis in the property.  The adjusted basis is the acquisition basis ( in your case inheritance basis of US$85,000 ) LESS accumulated depreciation ( per US rules ).   When there is a gain, that portion of the gain that was due to accumulated depreciation is treated as ordinary gain while the rest receives Capital gain treatment.  TurboTax will walk you through all of this.

Is there more I can do for ?

Auf Wiedersehen

pk 

[AmeliesUncle]

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@pk wrote:

1. Inherited a property  in 2018 with a Fair Market Value of US$100,000  ( at the then exchange rate ) along with a local tax of  US$ 15,000.  Hence the net basis of the property received is US$85,000 -- all using the exchange rate at the time.

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Wouldn't the Basis be $115,000?  The inheritance tax would be added to Basis, not subtracted.

[pk]

@angela94 , @AmeliesUncle , you are correct  in that the inheritance taxes paid should be added to the basis  since there is no other way to allow for the tax. I stand corrected -- replace all  references of US$85,000 with US$115,000.   Please forgive the error

[pk · Accepted solution]

@angela94 , @AmeliesUncle , you are correct  in that the inheritance taxes paid should be added to the basis  since there is no other way to allow for the tax. I stand corrected -- replace all  references of US$85,000 with US$115,000.   Please forgive the error.   The amount would have been correct if there was ONLY cash received and one had to pay inheritance tax on that amount.

[Anonymous]

and I question whether inheritance taxes add to basis.  I have no code section to cite. do you?  fair market value is normally the basis of inherited property.  that would be $100K.  

fair market value (FMV) is the price that an asset would sell for on the open market. Fair market value has come to represent the price of an asset under the following usual set of conditions: prospective buyers and sellers are reasonably knowledgeable about the asset, behaving in their own best interest, free of undue pressure to trade, and given a reasonable time period for completing the transaction. Given these conditions, an asset's fair market value should represent an accurate valuation or assessment of its worth.

the inheritance taxes paid would not be a 1040 Schedule a deduction.

[pk]

@Anonymous , I do not wish to belabor the point -- understand your  view as FMV being "always " the basis of one's acquisition.  

1. When one acquires a property the basis is the acquisition cost NOT FMV ( no matter how defined). The assumption  that FMV is the same as acquisition is not always true  e.g.  if the buyer pays all /part of the costs of selling that has to be accounted somewhere  and this gets complicated where especially in countries where it is customary for the buyer and seller to share costs of the sale.

2. Just like Estate tax is a tax for the right to transfer, inheritance ( does not exist currently in USA ) tax is a transfer tax for the right to receive and is often in lieu of  or addition to estate tax.  Many countries also have  wealth tax.  I view this inheritance tax as a transfer tax as a cost of acquiring the property and hence must be added to the basis. 

3. Because US has no inheritance tax , it is difficult to find words with which to search for foreign inheritance tax handling/recognition for assets other than  cash ( in which case you would reduce the actual disbursement  by the taxes paid at source not as income tax for purposes of form 3520).  I am sure either in private letter rulings  or tax court rulings   or  IRS rules/regs this has been covered but just know how to search for this .  If I find any I will come back  and/or correct my position.  MY point is that somehow the taxpayer has to account for all expenses associated with acquiring the asset  whether bought, inheritance, gift or otherwise .

4. The taxpayer's adjustment of basis by costs/taxes paid in acquiring the asset will stand IRS fairness doctorine audit.

[angela94]

Thanks so much @pk for sharing your expertise and insight, and also @Anonymous and @AmeliesUncle  for also raising questions, which provided further clarification.  This is the first time I've used this community, and WOW. I tried to reach out to the IRS on this, but it seems to be well beyond their scope of support.

I really appreciate your time and thought.

[pk]

@angela94 , you are quite welcome