Reporting capital gains on sale of land in India in Federal and California returns

[sabasu]

Hello Gurus,

I am an US citizen and resident of California. I sold a piece of land in India in July 2024. The Indian tax authorities deducted a hefty tax at source (a.k.a TDS, Tax Deducted at Source), from my sale proceeds @~24%. This is kinda a witholding tax to be adjusted against my Indian Tax Return (a.k.a ITR) next year. BTW...India's fiscal year runs from April to Mar, so I will file my ITR after April 2025 and expect to get a refund out of my TDS.

Now, here are my questions :

1. Do I need to report this sale and include the capital gains in my Federal tax return of tax year 2024 even though US and India has a Double Tax Avoidance Agreement (DTAA)? 

2. If the answer is YES, do I or how do I report the capital gains made in Indian Rupees (INR) and more importantly how do I claim the capital gains taxes paid, because so far, I have only paid the TDS and not the actual LTCG in India. Note : Because of the DTAA b/w US and India, I do not neccessarily want to claim Foreign Tax credit, if I do not have to show the sale of property and the capital gains in my Federal return.

3. This is the most intriguing question. Do I have to report this sale of land in my California tax return? I have heard that even though US and India has a DTAA treaty, California doesn't respect that. If that is true, how do I report this sale of property and do I get any deduction/credit for the deemed taxes (i.e. not yet paid) for LTCG?

Thanks in advance to the respondents.

[SusanY1 · Accepted solution]

As a US citizen, you do need to report all of your worldwide income, including any income subject to a Tax Treaty (or DTAA).  The DTAA doesn't alleviate the requirement to report the income, but rather tells us how to treat the income on the tax return.  Different types of income are often treated in different ways.  

You can see the treatment of gains in Article 13 of the US-India Tax Treaty.  (As you will see, it doesn't say a whole lot.) 

You will report the sale in the same manner as you will a US capital gain but you will convert to USD.  You can use any reasonable method to make your conversion.  Since the transaction occurred on a specific day, you may wish to translate using that day's average exchange - but you're not required to do so.  

Another acceptable method is to use the average annual exchange, as found here: Yearly average currency exchange rates.  

The most beneficial treatment for you on your US tax return will likely be to take a foreign tax credit for the tax (converted to USD) paid on your gain.  TurboTax (when fully available) will walk you through this - but that section can sometimes be a little tricky so please do come back and let us know how we can help once you're ready to file.  You are allowed to take a credit for the accrued ("deemed") taxes, even though you will pay them at a later date.  

For California, you will unfortunately have to report the gain as taxable income since you are a full-time resident of the state.  There is not an equivalent tax credit on the California return for foreign taxes paid.  However, you can include the California tax paid on foreign income as foreign taxes paid when calculating your federal tax credit.  See this discussion on that topic.  You will have to prepare your federal return, then your California return to determine that tax paid.  Then you will return to the federal portion to include that additional tax. 



 

[sabasu]

Thank you for the detailed answer. I obviously have a few followup questions, feel free to answer them. I fully understand that your response is not a professional advice and will use it on my own risk. And thanks in advance anyway.

You wrote "You are allowed to take a credit for the accrued ("deemed") taxes, even though you will pay them at a later date..." This is really helpful . I sold the property in July 2024, which falls within FY24 - 25 Fiscal Year for India and ends on 31 March 2025. Therefore, I can only file the Indian tax return on or after April 1, 2025, though it might not be possible to file it before the US Tax Day. As such, I might take an extension on my US taxes and take a Foreign Tax credit for the ACTUAL taxes paid on the Indian Tax Return (converted to USD) instead of "deemed taxes". Does this sound reasonable?

You wrote "For California, you will unfortunately have to report the gain as taxable income...". Do I report this separately OR where do I report this in my California return OR does this get automatically derived by TurboTax from my Federal return like my other incomes?

You wrote "...However, you can include the California tax paid on foreign income as foreign taxes paid when calculating your federal tax credit.... You will have to prepare your federal return, then your California return to determine that tax paid.  Then you will return to the federal portion to include that additional tax."

I looked at the discussion and tried to digest your response along with the answer provided in that discussion. This is what I understood.

Step 1. I prepare my federal return. In Line 1(a) of Form 1116 is where I report my foreign income (which is basically the Capital Gains on the sale of my property in India, converted to USD).

Step 2. I prepare my California return to determine California tax paid. 

So, after Step 1 and Step 2, both my Federal and California returns INCLUDES my normal US incomes PLUS Indian Capital Gain income, right? If this is true, then California taxes also include that portion of the taxes attributed to Indian Capital Gain income? I understand that I have to go back and add this portion of California taxes in Part II of Form 1116. However, I am having a hard time understanding how do I figure out that portion of California taxes attributed to Indian Capital Gain income? Should I do the taxes twice, i.e. one with the foreign Capital Gains and one without and assume the difference between California taxes as taxes paid on the foreign Capital Gain to be deducted as Foreign Tax Credit in Line II of Form 1116?

Again, sorry for the long post. Feel free to answer or not.

Thank you so very much.