Foreign Tax Credit to offset capital gains tax and depreciation recapture

[smicp]

I own a house abroad and get rental income from it. I pay income taxes on the rental income in the foreign country. Because of how the FTC is calculated, I get a very small credit each year, and a large chunk of it is carried forward.

In a few years, if I decide to sell the house, I will have to pay a large amount due to the capital gains tax and depreciation recapture. Will I be able to offset this amount using the FTC carried forward?

[pk]

@smicp , generally speaking the carried  Foreign Tax Credit while  reducing your US  tax burden  may or may not extinguish  your total US tax burden -- this is  because :

(a)  form 1116  ( Foreign Tax Credit form ) ,limits  your allowable  tax credit to lesser of  the allocated  US tax to the   doubly taxed income  OR  the actual Foreign Taxes paid.  It is almost a never winning battle.

(b)  the gain  computed on the disposal/ alienation of foreign asset  is done per US tax laws and may be different  from the country where the property is located

(c)   Then there is the depreciation recapture -- ordinary  / marginal tax rate  for that part of the gain that is due / equal to the accumulated depreciation  and capital gain treatment for the rest of the gain.

I recognize that I am not  really adding anything to your statements in your post -- just making sure we are on the same page.

By the way , which country are you talking about ?

I am assuming that you are a US person  (  citizen / GreenCard / Resident for tax purposes ).

Is there more I can do for you ?

pk

[smicp]

Hi @pk,

Thanks a lot for your reply.

Please see my reactions to your points below:

(a) My rough calculation suggests that in the year the house is sold, the allocated US tax to the doubly taxed income would be significantly higher and would yield a significantly higher allowable tax credit. This is because the share of taxable income from foreign sources (after all the definitely related deductions and the pro-rata allocation of non-definitely related deductions) on total taxable income from all sources would be high, assuming that the capital gains (incl. depreciation recapture) from the sale of the house count as foreign income. Total tax due would also be high (because of the capital gains tax and depreciation recapture), so high share of taxable income from foreign sources combined with high tax due gives a relatively high maximum amount of credit allowed. This would allow me to use the FTC from the year of the sale of the house, as well as most of the FTC carried over from previous years. Does this seem reasonable?

(b) Yes, in my calculations above I am assuming the gain is computed as per US tax laws.

(c) Yes, in my calculations above I am dividing the gain into capital gain (taxed at 15% based on my assumptions) and depreciation recapture (taxed at the marginal taxation rate as ordinary income).

The country is Italy, where you pay income tax on rental income, but there is no capital gains tax or depreciation recapture when you sell a rental property.

Yes, I am a US person.

[pk · Accepted solution]

@smicp , generally agreeing with your statements I.e.

1.  Your total foreign source income would be your gross gain from the alienation of the property : i.e.  the  difference between  Sales Proceeds  (  Sales price LESS  allowable sales  expenses including any commission, transfer tax etc. ) and  Your adjusted basis (  Acquisition basis   + cost of any improvements  over the years LESS accumulated allowable  depreciation over the period as income property ).  This is the income being doubly taxed.

2. Your Foreign taxes paid on this income is  current taxes  paid PLUS your  Foreign Tax Credit carried forward ).

3.  Your total Foreign Tax credit allowable for current tax year ( the year of recognition of the disposal of the asset ) is the lesser of the actual taxes  paid / accrued  OR   allocated UIS taxes on this foreign sources income.

Hope this makes sense .

Please consider accepting and/or upvoting  this thread ( we are volunteers helping other users ) OR tell me what more I can do for you to earn your support.

pk

[smicp]

Thank you, @pk. This is very helpful.