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

The Villa That Cost More on the Way Out Than the Way In

In 2015, an American retiree buys a €400,000 villa in Portugal, financing €300,000 with a euro-denominated mortgage. By 2025 the euro has weakened against the dollar, the property has appreciated only modestly, and she sells at what looks, in euros, like a break-even deal. Her Portuguese accountant confirms no local capital gains tax is due after allowances. Then her US preparer runs the numbers and finds a five-figure federal tax bill — not on the sale of the house, but on the currency gain embedded in paying off the euro mortgage. Under Internal Revenue Code Section 988, the dollar value of that loan shrank between origination and payoff, and the IRS taxes that shrinkage as ordinary income, regardless of what happened to the property itself (Greenback Tax Services, 2026).

This is the pattern that trips up American expats who own real estate abroad: the property itself is usually simple to hold, but individual mechanics of US tax law — citizenship-based taxation, foreign currency rules, and a temporary but still-active provision from the 2017 Tax Cuts and Jobs Act (TCJA) — create liabilities that have nothing to do with local tax rules. Below is what actually triggers a US filing obligation, what doesn't, and where the money is actually owed.

The Baseline Rule: Citizenship-Based Taxation Doesn't Pause at the Border

The United States is one of the only countries that taxes citizens on worldwide income regardless of residence (the other being Eritrea). Owning a foreign property doesn't change this. Rental income, capital gains, and currency gains connected to foreign real estate are all reportable on a US return every year, filed by the regular deadline (April 15, with an automatic extension to June 15 for taxpayers living abroad, per IRS rules on U.S. citizens and resident aliens abroad). Local tax paid to the country where the property sits generally offsets US tax through the Foreign Tax Credit (Form 1116), but the US return still has to be filed — foreign tax paid doesn't excuse the filing itself.

Buying the Property: What You Do and Don't Have to Report

The purchase itself is the easy part. Directly-held foreign real estate is explicitly excluded from two of the most feared expat reporting regimes:

• **FBAR (FinCEN Form 114):** This form covers foreign financial accounts — bank, brokerage, and similar accounts — once the aggregate balance across all foreign accounts exceeds $10,000 at any point in the year. Real property held directly, in your own name, is not a financial account and is not reported (FinCEN; comparison guidance at IRS.gov, 2026).
• **Form 8938 (FATCA):** Same exclusion — real estate held directly is not a "specified foreign financial asset" (IRS, Basic Questions and Answers on Form 8938, 2026).

That changes the moment you hold the property through a structure. If you buy through a foreign corporation, partnership, or trust, your *interest in that entity* becomes reportable on Form 8938 once you cross the threshold — $200,000 on the last day of the year (or $300,000 at any point) for a single filer living abroad, and $400,000 / $600,000 for a married couple filing jointly living abroad (IRS, 2026). The real estate isn't listed separately, but its value flows into the entity's value for that calculation.

One structure deserves specific mention because it's mandatory, not optional, for coastal and border property in Mexico: the **fideicomiso**, a bank trust required by Mexican law for foreign buyers within the restricted zone (50 km of the coast, 100 km of a border). For years, practitioners debated whether this arrangement triggered US foreign trust reporting (Forms 3520/3520-A, with penalties starting at 35% of the amount involved for late filing). The IRS resolved this in **Revenue Ruling 2013-14**: a standard fideicomiso where the bank holds only bare legal title is not a trust for US tax purposes, and 3520/3520-A filings are not required (IRS Rev. Rul. 2013-14, 2013). Rental income and any linked Mexican bank account are still reportable in the normal way.

If you finance the purchase with a mortgage from a foreign bank, note the loan itself: interest is deductible under the same rules as a US mortgage, provided the property qualifies as a first or second home. The TCJA capped the deductible mortgage debt at $750,000 for loans taken out after December 15, 2017 (or $1 million for older loans) — a foreign property doesn't get a separate limit, it shares the cap with any US home you also own (IRS Publication 936; Journal of Accountancy, 2018).

Owning It: Rental Income, Depreciation, and a Deduction TCJA Took Away

If you rent the property out, even seasonally, the income is reported on Schedule E of Form 1040 alongside any US rental properties. Two mechanics are specific to foreign property:

**Depreciation runs longer than for a US property.** Foreign rental real estate must be depreciated under the Alternative Depreciation System (ADS), using straight-line calculation. For residential rental property placed in service after December 31, 2017, the recovery period is 30 years (property placed in service earlier uses 40 years, and non-residential/commercial foreign property still uses 40 years). ADS also blocks bonus depreciation entirely (IRS Publication 946; Journal of Accountancy analysis, 2026). Compare that to the 27.5-year schedule for US residential rental property — the foreign version depreciates more slowly, which means a smaller annual deduction against rental income.

**Foreign property taxes are no longer deductible — for personal use.** Before 2018, real estate taxes paid to a foreign government were deductible as an itemized deduction, just like US property taxes. The TCJA eliminated that deduction specifically for foreign real property taxes not connected to a trade or business, for tax years 2018 through 2025 (Journal of Accountancy, "The TCJA and Foreign Real Property Taxes," 2018). If the property is a personal vacation home, the local property tax bill is simply gone as a US deduction. If the property is a rental — an income-producing activity — the tax remains deductible as a business expense on Schedule E. The distinction is whether the property is personal-use or generates income, not where it's located.

Rental losses are also subject to the normal US passive activity loss rules, meaning a non-real-estate-professional's foreign rental losses generally can only offset passive income, not wages, unless the $25,000 active participation allowance applies and phases out between $100,000–$150,000 of modified adjusted gross income.

Selling It: The Section 121 Exclusion Works Abroad, Currency Gains Don't Care

Section 121 — the home sale exclusion that lets a single filer exclude $250,000 of gain ($500,000 married filing jointly) — applies to a foreign primary residence exactly as it would to a US one. The requirement is the same two-part test: you must have owned *and* used the home as your main residence for at least 24 months out of the 60 months before the sale, and you can only use the exclusion once every two years (IRS Publication 523; TaxesForExpats, 2026). Gain above the exclusion amount is a capital gain, and foreign tax paid on that gain can generally be credited against US tax via Form 1116.

The part that catches people off guard is the currency mechanics of paying off a foreign-currency mortgage, illustrated by the Portugal example above. Under Section 988, a foreign-currency loan is treated as a separate financial transaction from the house. If the dollar weakened against the local currency between when you took out the loan and when you paid it off (or the property was sold and the loan retired), you have a taxable currency gain — taxed as **ordinary income**, at rates up to 37%, not as a capital gain (Greenback Tax Services, 2026). Three specifics make this worse than it sounds:

1. **Section 121 does not shelter it.** The home sale exclusion applies to the gain on the *property*. The currency gain on the *mortgage* is a separate calculation and is fully taxable even if the entire home-sale gain is excluded.
2. **It doesn't net against a real estate loss.** If the property sells for less than its basis, that's a separate capital loss calculation. The mortgage currency gain is still taxed as income, so you can genuinely owe federal tax in the same year you sold a house at a loss.
3. **Currency losses on personal-use mortgages generally aren't deductible**, while currency gains are always taxable — an asymmetry, not a matching offset (American Citizens Abroad, "Currency Fluctuations and Phantom Gains").

The only real planning lever is the size and currency of the loan itself: a smaller foreign-currency mortgage, or one paid down steadily rather than in a lump sum at sale, produces a smaller currency gain calculation.

Estate Planning: Foreign Property Is Part of Your Worldwide Estate

Unlike a nonresident, non-citizen owner (who is only taxed on US-situs assets for estate tax purposes), a US citizen's estate includes worldwide assets, foreign real estate included. As of January 1, 2026, the federal estate and gift tax exemption is $15 million per individual, made permanent (not subject to the prior law's scheduled sunset) by the One Big Beautiful Bill Act, signed July 4, 2025, and set to index for inflation starting in 2027 (Morgan Lewis, "IRS Announces Increased Gift and Estate Tax Exemption Amounts for 2026," 2025). A married couple can shelter $30 million combined. That exemption is high enough that most expat households won't owe federal estate tax on foreign property — but the property may still be subject to the host country's own inheritance or succession tax rules (common in civil-law countries like France and Spain, which impose forced-heirship rules independent of a US will), which is a separate liability from anything owed to the IRS.

Practical Takeaways

• **File every year, regardless of local tax paid.** Rental income and gains are reportable on your US return whether or not any US tax is ultimately due after the Foreign Tax Credit.
• **Confirm direct ownership before assuming no FBAR/8938 filing is needed.** The exemption applies to direct title; entities, trusts, and certain fideicomiso variants can change the answer.
• **Track your mortgage's currency exposure, not just the property's value**, if the loan is in a foreign currency. Model the Section 988 calculation before you pay off or refinance a large foreign mortgage.
• **Keep foreign property tax records separated by use.** Personal-use property taxes aren't federally deductible under current law (2018–2025); rental-property taxes still are, as a Schedule E business expense.
• **Use the correct depreciation life.** Foreign residential rental property placed in service after 2017 depreciates over 30 years under ADS, not the 27.5-year US schedule — get this wrong and you'll need to file Form 3115 to correct it.
• **Confirm your Section 121 eligibility with dates, not memory.** The 24-of-60-month ownership and use tests are calculated to the day; travel and moves between countries can quietly break the test.
• **Ask about host-country inheritance and forced-heirship rules separately from US estate tax.** A $15 million federal exemption doesn't protect against a French forced-heirship claim or a local succession tax.

Next Steps

Find a preparer who specifically handles cross-border returns — a US-only CPA and a local accountant, working independently, will each competently apply their own country's rules and still miss the interactions between them, particularly the Section 988 currency mechanics and the ADS depreciation requirement. Before selling a foreign property financed with a foreign-currency loan, get the currency-gain calculation run *before* the closing date, not after, since the debt payoff mechanics are what create the taxable event. And if you're still deciding whether to buy, ask any recommended local structure (a fideicomiso, an SCI, a foreign holding company) how it will be classified for US purposes before you sign, since restructuring after the fact is far more expensive than confirming it up front.