US Tax Implications of Foreign Real Estate: What American Expats Actually Owe

# US Tax Implications of Foreign Real Estate: What American Expats Actually Owe

Here is a scenario that catches American expats off guard every year. You buy an apartment in Lisbon for €300,000, financed with a euro mortgage. Years later you sell it, the euro having weakened against the dollar in the meantime. You correctly claim the Section 121 exclusion and pay no US tax on the gain from the home itself. Then your accountant tells you that paying off the euro mortgage triggered a separate "foreign currency gain" under Internal Revenue Code Section 988—taxed as ordinary income, with a bill running into five figures. The Section 121 exclusion does nothing to shelter it.

This is the central reality of owning property abroad as a US citizen: the United States taxes its citizens on worldwide income regardless of where they live, and foreign real estate sits inside a thicket of rules that frequently surprise even financially sophisticated owners. The good news is that the property itself is usually invisible to the IRS's main reporting forms. The complications live in the income it produces, the currency it's denominated in, and the way it's owned.

Here is what American expats actually owe—and report—on foreign real estate.

The Reporting Trap That Isn't Where You Think

Start with what is *not* reportable, because the conventional fear is misplaced. Foreign real estate held directly in your own name is **not** a "specified foreign financial asset." It does not go on Form 8938 (the FATCA disclosure), and it is not reported on the FBAR (FinCEN Form 114). The IRS states this plainly in its Form 8938 guidance: a foreign personal residence or directly held rental property is not a reportable asset (IRS, *Basic Questions and Answers on Form 8938*).

The trap is in the qualifiers "directly" and "the property itself."

• **The foreign bank account you use to collect rent or pay the mortgage IS reportable.** If the aggregate value of all your foreign financial accounts exceeds **$10,000 at any point** during the calendar year, you must file an FBAR. It's filed electronically through the Treasury's BSA E-Filing System, due April 15 with an automatic extension to October 15 (IRS, *Report of Foreign Bank and Financial Accounts*). A single month of rent sitting in a local account can push you over the line.
• **Property held through a foreign entity IS reportable.** If you own the real estate through a foreign corporation, partnership, LLC, or trust—a structure many buyers adopt on local advice in places like Mexico or the Philippines—your *interest in that entity* is a specified foreign financial asset reportable on Form 8938, and may also trigger Form 5471, 8865, or 8858. For taxpayers living abroad, Form 8938 is required when specified foreign assets exceed **$200,000 on the last day of the year or $300,000 at any point** (single filers), or **$400,000 / $600,000** for joint filers (IRS, *Do I Need to File Form 8938?*). The penalty for not filing starts at $10,000 and climbs to $50,000.

The practical lesson: holding structure determines your reporting burden far more than the property itself does. Many owners create filing obligations—and PFIC exposure—they never needed by titling a personal home inside a corporation.

Rental Income: Reported in Dollars, Depreciated Over 30 Years

If you rent the property out, the income is taxable in the US and reported on Schedule E, converted to US dollars. You may deduct the usual expenses—management fees, repairs, insurance, local property taxes, and mortgage interest—against that rental income.

Note the contrast with personal-use property: the Tax Cuts and Jobs Act eliminated the itemized deduction for foreign real property taxes on Schedule A for tax years **2018 through 2025** (IRC §164; *Journal of Accountancy*, December 2018). So the property tax on your overseas vacation home is no longer deductible—but the property tax on a rental still is, because it's a business expense on Schedule E rather than a personal itemized deduction.

Depreciation is where foreign rentals diverge most sharply from domestic ones. US residential rental property is depreciated over 27.5 years. Foreign residential rental property must use the **Alternative Depreciation System (ADS)**, straight-line, over a longer recovery period: **30 years for property placed in service after December 31, 2017** (40 years for property placed in service before that date), per IRC §168(g) and IRS Publication 527. The result is a smaller annual depreciation deduction than a comparable US property would generate.

Depreciation is not optional, and it has a sting in the tail: when you sell, the IRS treats you as having taken depreciation whether you claimed it or not, and recaptures it as income taxed at rates up to 25%. Skipping the deduction does not let you skip the recapture—so claim it.

Selling the Property: The Exclusion Travels, the Currency Math Doesn't Forgive

The Section 121 exclusion—up to **$250,000 of gain for single filers, $500,000 for married couples filing jointly**—applies to a principal residence *wherever it is located*, including abroad, as long as you owned and used it as your main home for at least **2 of the 5 years** before the sale (IRC §121; IRS Publication 523). A US citizen who lived in a Berlin apartment as a primary home for three years can exclude the gain on the same terms as someone selling in Denver.

Two complications follow.

**Gain is computed in US dollars at the exchange rate on each date.** You convert the purchase price to dollars using the exchange rate when you bought, and the sale price using the rate when you sold. If the local currency strengthened against the dollar over your ownership period, you can owe US tax on a "gain" even if the property's value barely moved in local-currency terms. The exclusion may absorb it; for investment property or gains above the cap, it won't.

**The Net Investment Income Tax can apply on top.** High earners face a **3.8% surtax** on net investment income—including taxable capital gains—when modified adjusted gross income exceeds **$200,000 (single) or $250,000 (married filing jointly)** (IRC §1411). Critically, the Foreign Tax Credit cannot be used to offset the NIIT, so expats can owe this 3.8% to the US even after paying capital gains tax to their country of residence.

The Phantom Mortgage Gain Nobody Budgets For

Return to the Lisbon scenario. Under IRC §988, the IRS treats a foreign-currency-denominated mortgage as a financial transaction *separate from the property*. In economic terms, borrowing in euros and owing dollars makes you effectively short the euro.

When you repay or refinance that loan, you recompute the debt in dollars at both the origination and payoff dates. If the foreign currency **weakened** against the dollar in between, it costs you fewer dollars to extinguish the debt than you originally borrowed—and that difference is a **taxable gain, taxed as ordinary income** (IRC §988; Cornell Legal Information Institute).

The asymmetries make this brutal:

• The Section 121 exclusion shelters the gain on the *home*, not the gain on the *mortgage*. You can sell tax-free and still owe on the loan payoff.
• A currency *loss* on a personal-use mortgage is generally **not deductible**—it's treated as a nondeductible personal loss. Gains are taxed; losses give you nothing.
• It is triggered by refinancing, not just selling. Restructuring a foreign mortgage to a better rate can realize the gain even though you never touched the property.

This is the single most overlooked liability in foreign homeownership, precisely because nothing about it feels like income.

Avoiding Double Taxation: The Foreign Tax Credit

You will often pay tax to the country where the property sits—on rental income, on the sale, or both. The Foreign Tax Credit (Form 1116) lets you credit foreign income taxes paid against your US tax on the same income, generally preventing true double taxation on rental income and capital gains.

Its limits matter. The credit applies to foreign *income* taxes, not to transfer taxes, stamp duties, or VAT. It does not offset the 3.8% NIIT. And the Foreign Earned Income Exclusion (Form 2555), which lets qualifying expats exclude up to **$130,000 of earned income in 2025** (IRS, *Instructions for Form 2555*), does not apply to rental income or capital gains—those are passive and investment income, outside its scope. For property income, the Foreign Tax Credit, not the FEIE, is your tool.

Practical Takeaways

• **Title property in your own name unless a professional gives you a specific, documented reason not to.** A foreign entity wrapper usually adds Form 8938, possibly Form 5471/8865/8858, and PFIC risk—for a personal home that would otherwise be invisible to the IRS.
• **File the FBAR if any foreign account crossed $10,000**, even briefly, including accounts opened just to handle the property. The threshold is aggregate and measured at any moment in the year.
• **Model the Section 988 mortgage exposure before you sell or refinance.** Pull the exchange rate on your loan origination date and run the dollar math on payoff. Budget for an ordinary-income bill if the local currency has weakened against the dollar.
• **Claim foreign rental depreciation on the 30-year ADS schedule**—recapture happens at sale whether or not you deducted along the way.
• **Keep dual records in local currency and US dollars** from the day you buy: purchase price, capital improvements, and closing costs, each converted at the contemporaneous exchange rate. Your eventual US gain is computed in dollars, and reconstructing rates years later is painful.
• **Use the Foreign Tax Credit for rental income and sale gains**, and remember it can't erase the NIIT—reserve cash for that 3.8% if you're above the MAGI thresholds.

Next Steps

Foreign real estate is one of the few areas where the US tax cost can swing dramatically based on decisions made *before* you buy—how you hold title, what currency you borrow in, and which account collects the rent. The reporting itself is manageable; the expensive surprises come from structure and currency, and most of them are avoidable with planning.

Before your next purchase, sale, or refinance, take three concrete steps: gather your exchange-rate records, confirm your holding structure won't create entity-reporting obligations, and consult a cross-border tax professional who specifically handles Section 988 and FATCA—not a generalist preparer. The IRS forms named here (8938, 2555, 1116, Schedule E, FinCEN 114) and their instructions are freely available on IRS.gov, and reading the relevant ones for your situation will make that professional conversation far more productive.

*This article is general information, not tax advice. Foreign property taxation turns on individual facts and any applicable tax treaty; confirm your position with a qualified cross-border advisor.*