For American expats, owning rental property abroad is a smart way to diversify and earn extra income. However, if you’re a US citizen renting out real estate in the UK – or anywhere else – there’s one thing you can’t ignore: how foreign rental income affects your US taxes. The US taxes its citizens on income from all over the world, so your overseas rent isn’t exempt.
Many expats get tangled up in confusing tax rules, exchange rates, and paperwork. That’s why it’s important to understand your US tax responsibilities regarding UK rental income. This article breaks down what you need to know, including how to report your income, which deductions you can claim, and how to avoid common issues like double taxation. Whether you’re an experienced landlord or considering buying your first UK rental property, understanding the rules now will prevent headaches later.
Do US citizens have to declare foreign property and rental income?
Yes, you do. As a US citizen or green card holder, you must report all your income, including that from foreign rental properties, on your U.S. tax return. For example, if you rent out a property in the UK, you must report that rental income to the IRS, even if you already paid taxes on it in the UK.
But it doesn’t stop there. If the total value of your foreign bank accounts – including those linked to your UK rental property – exceeds $10,000 at any time during the year, you must file an FBAR (Foreign Bank Account Report). Depending on how many foreign properties or assets you own, you may also need to file Form 8938 under FATCA rules.
Understanding these requirements is key to effectively managing American expat taxes. Failure to make these filings can lead to serious penalties. Therefore, knowing exactly what you need to report is essential for every American expat with overseas property.
How to report foreign rental income on your US tax return
Reporting foreign rental income is similar to reporting rental income from a property in the US, but there are a few key differences. As a US expat, you’ll use Schedule E of Form 1040 to report your rental income and expenses.
The first step? Convert all your foreign income and expenses into US dollars. The IRS requires you to use their approved exchange rates, either the exact rate on the day you received the money or the yearly average if the income was received steadily throughout the year. It’s important to keep careful records of exchange rates to get this right.
List all your rental income and subtract allowable expenses, such as mortgage interest, repairs, and property management fees. We’ll discuss those in more detail next. Remember, losses may be limited by passive activity loss rules, especially if your income is high.
If you paid UK taxes on this rental income, you can use Form 1116 to claim a foreign tax credit. This helps reduce the risk of being taxed twice.
Tax deductions and allowable expenses for foreign rental property
One perk of owning a rental property, whether in the US or abroad, is that you can deduct related expenses to lower your taxable income.
The IRS allows a range of deductions for foreign rental properties that are pretty similar to those for US rentals. Common deductible expenses include:
- mortgage interest
- property taxes (including foreign property taxes);
- insurance premiums
- repairs and maintenance
- property management fees
- utilities
- depreciation
Foreign property taxes usually qualify as a deduction, either as an itemized deduction or against your rental income, so keep those records handy.
Depreciation is important. The IRS lets you depreciate foreign residential rental property over 30 years, which is longer than the 27.5 years allowed for US properties. This spreads out the deduction, but it’s still valuable.
Keep all your receipts, invoices, and bank statements. You will need proof if the IRS ever asks for it. Remember, only expenses directly tied to renting the property count. Personal expenses or upgrades don’t.
Carefully tracking and claiming these expenses can make a big difference in your tax bill. Staying organized and getting expert advice is always a smart move.
How to avoid double taxation on foreign rental income
What is one of the biggest worries for US expats renting UK property? Getting taxed twice – once by the UK and again by the IRS. Fortunately, the US tax system offers a solution.
It’s called the Foreign Tax Credit (FTC). Essentially, it allows you to subtract the UK income tax you’ve already paid from what you owe the IRS on the same rental income. To claim this credit, file Form 1116 with your tax return. This can reduce or even eliminate your US tax liability on that income, but you must keep good records and calculate it carefully.
One important point is that you can’t claim a deduction and a credit for the same foreign taxes. Usually, the FTC is the better choice.
The UK-US tax treaty provides additional guidance, spelling out which country gets to tax what. This helps prevent confusion or double charges. Talking to a tax professional who is familiar with expat tax treaties can ensure that you are using these rules to your advantage while staying compliant.
Capital gains tax considerations when selling UK rental property
Are you selling your UK rental property? The IRS wants its share of the capital gains, even if you already paid capital gains tax in the UK.
Here’s how it works: Your capital gain is the difference between the sale price and your adjusted basis, which is your purchase price plus any improvements or expenses. Then, convert that number into US dollars using the exchange rate on the sale date.
Unlike primary homes, rental properties usually don’t qualify for the substantial capital gains exclusion – $250,000 for individuals and $500,000 for couples – unless you lived in the property as your main residence for at least two out of the last five years.
Also, keep in mind that currency fluctuations can affect your gain or loss. This makes accurate recordkeeping and currency conversion even more important.
While there’s no simple way to legally avoid capital gains tax, strategies such as timing your sale or using a 1031 exchange (which has limits for foreign properties) may help you defer the tax. Since this is complicated, it’s wise to consult a tax professional before selling.
Additional reporting and compliance requirements
Owning a foreign rental property involves more than just reporting income. If the total value of your foreign bank accounts associated with your UK rental property exceeds $10,000 at any point during the year, you are required to file an FBAR (FinCEN Form 114). Additionally, if your foreign assets reach certain limits, you must also file IRS Form 8938 under FATCA rules.
Missing these filings isn’t a small mistake. Penalties can be steep – sometimes higher than the taxes you owe. That’s why it’s crucial to keep accurate records and understand what you need to report to avoid costly errors.
Conclusion
As a US expat owning UK rental property, you face a fair share of tax challenges. However, with proper reporting, deductions, and planning, you can remain compliant with the IRS and manage your tax liability effectively. Working with a tax professional who is familiar with expat rules can make this process much easier and help you avoid common pitfalls.