Sale of vacation home in foreign country with no foreign tax paid but foreign tax credit available

[alexandeributenk]

Hi! I have a weird question that TurboTax Tax Experts doubt on...

1. I have some foreign tax credit carryover from previous years. Few thousand dollars.

2. I was using apartment in Ukraine to receive additional income (rental income) but last year sold it. This property was entered in TurboTax as a foreign property (it asked for country). When I told TT it's sold it generated form 4797 and calculated long-term capital income this way: sale proceeds MINUS original cost MINUS expenses to sell PLUS depreceation I previously took. I assume this math is correct but it resulted in few thousand capital gain which I need to pay capital gain tax in US.

3. No tax on sale of that property was required in Ukraine as it was my only apartment and only one sale a year. It's their law. No tax paid in that country.

Now I'm thinking... Can I report the entire income from this sale as foreign sourced income and offset it with my existing foreign tax credit carryover? Again, no tax was paid to sell this property but foreign tax credit was accrued previous years for different reasons but it's still here. Can I use it?

However, as I see in TurboTax if I report it as sale normally it generates Form 4797 which doesn't allow to say it's foreign income. So, proceeds from this form are automatically added to my long-term capital gain and I do not see any way to offset it with foreign tax credit in any other form. The only way to offset it is not to report it as sale with TurboTax so 4797 will not be generated. Instead, I can open Form 1116 and tell it I had additional passive income, enter it there and offset it with foreign tax credit. If I do this way 4797 will not be generated but Form 1116 will just have one new line with some foreign passive income.

But is this correct? Am I legally allowed to report income from foreign property sale this way? It will result in 0 US taxes. Here I'm confused.. Is accrued foreign tax credit used ONLY to offset foreign tax paid (which was not) or it can also be used to offset foreign capital gain even if no foreign tax paid...

One important note here. I already filed with IRS electronically putting it to 4797 and not using Foreign Tax Credit. So, to use Form 1116 strategy I need to file amendment and put explanation in notes basically telling the IRS "I created form 4797 but now I think it's foreign income so I'm removing this form and adding it to 1116 and by the way Uncle Sam you owe me some additional refund now...".. Will IRS accept this? Can it trigger tax audit?

I've asked TurboTax experts and they were really confused saying it's super complicated question. One of them said I can do this and in case IRS doesn't accept they will support me during audit.

But I don't want to do something if it's not allowed upfront which I do not know...

Anyone can advice?

[rogge1722]

From Pub 514, page 38 under the heading:

Taxes All Credited or All Deducted

"You cannot claim a credit for unused foreign taxes in a year to which you carry them unless you also claim a credit for foreign taxes actually paid or accrued in that year."

If you have no foreign taxes paid for the category of income you are using, it appears you cannot claim a credit.

[alexandeributenk]

Yes, thanks for your reply! It sounds I can't.....

[pk]

@alexandeributenk , having read through your post and the comments  by @rogge1722 ,  I still have a few questions:

(a) what is it you are trying to achieve -- use up the foreign tax credit OR reduce your over-all tax liability for the tax year ?

(b) when did you enter USA and when did you become a US person  ( citizen/ GreenCard / Resident for tax purposes )?

(c) when did you buy the property in Ukraine, did you use it as your main residence, when did you rent the property ( when to when ) and when did you sell the property ?

I will circle back once I hear from you 

pk

[alexandeributenk]

Hi, thanks for getting back!

a) need to be very careful answering here as I might be getting some terms wrong.

Don’t really care about accrued foreign tax credit. I see this real estate sale resulted in some capital income that resulted in IS tax

liability (no tax in other country). So the goal is to pay less tax in US.

b) I guess the date I became US tax resident is the same date my green card was issued (day of entry). That was mid 2017. My first tax returns filed for 2017.

c) it was acquired a while ago, 2003 I guess. According to what I know I should pay capital tax based on its value the moment I became US tax resident in 2017.

It was my primary residence until mid 2018 but after that I stopped living there. It was used by my friend with no compensation. Starting 2021 I started getting rental income. I was getting this income 2021, 2022, 2023 until it was sold end of 2023. For all those 3 years I was taking depreciation as TurboTax proposed. As it wasn’t my primary residence any moment for the last 5 years I own the tax.

TT calculated it this way:

Sale proceeds (-) Sale related costs (-) Initial price (+) Total depreciation taken for those 3 years.

here base cost is basically how much it was the moment I became US resident.

so for me TT calculation of  income seems correct but what I doubt about is can I deduct this income using foreign tax credit…. According to the reply above from rogge1722  I can’t as paid no foreign tax in 2023:( is that all correct?

[pk]

@alexandeributenk , from your post  what i get of the situation is as follows:

(a)  You a US person for  tax year 2023

(b) you  converted your home   ( owned since 2003 ), to income property in  2020

(c) You reported income and expenses  ( including depreciation ) on Schedule-E  since tax year 2020.

(d) You sold this property in 2023.

(e) you have unused foreign tax credit

(f) You have no foreign tax on the swale of the  asset in Ukraine

1. Because  this was your home , if you had sold the property within five years  of  leaving the property  you would have met the " Sale of Main home " exclusion.  This  is no longer available to you  because  with a look back  of five years  from 2023,  while you would meet the ownership ( 2 years  by either spouse ) but would miss the "use as main residence" because you stopped using it  as a main residence  in 2017/18.

2.   Taxable gain is  computed  as   Sales Proceeds  (= Sales Price - sales expenses such as  realestate commission, transfer tax , repairs for purposes of sale etc. etc. )  LESS   Basis   (  =  Acquisition cost + Cost of any improvements  during the intervening years - Accumulated  allowable depreciation ).

3. This  gain  is taxed two different  ways ---- that portion of the gain equal to accumulated depreciation is taxed as ordinary income ( at your marginal rate );  the rest of the gain  ( i.e. gain LESS accumulated depreciation ) is  taxed at a lower  capital gain rate).

I don't know if this answers your question.

If you need more help please  add to this thread and I will circ le back

pk

pk

[alexandeributenk]

Thanks! I basically agree on the following however need to mention it seems TurboTax didn't split ordinary income and capital gain. It simply added accumulate depreciation with capital gain calculated the way you described it. Again, wasn't my decision. TurboTax asked how much depreciation accumulated and produced total number that I can easily check and it's everything combined. I'd prefer to leave it to TT.

The question I still have here if I can offset all this or part of this income with my foreign tax credit? As you see I'm not concerned about my ability to claim it's my main home (as it isn't). All that is pretty clear. But we clearly have income that I should pay taxed on. My most important concern is if I'm able to use foreign income tax credit accrued in 2017-2018 and carryovered to 2023 to offset all or part of this income....

[alexandeributenk]

I guess I’m not allowed to use foreign tax credit to offset US tax on that income from foreign apartment sale as no foreign tax paid on it… 

Was worth checking though 😉

[DaveF1006]

Yes, this is correct. If no foreign tax was paid, you can't claim a credit.