Foreign Homes and Estate Plans
Don't overlook foreign assets when planning your estate. If you own real estate outside the U.S., you should address the assets in your estate plan. But watch out for double taxation. There's that risk if the assets are subject to estate, inheritance or other death taxes in the country where you own the property. You may be entitled to a foreign death tax credit against your U.S. gift or estate tax liability, particularly in countries that have tax treaties with the U.S.
When you die, the property falls under the jurisdiction of that nation. A probate lawyer may need to be hired in that jurisdiction. Simplify the process by putting the assets in a living trust, using a beneficiary deed or adding an owner with joint survivorship rights to the asset.
You don't have to tell the IRS that you're buying a home in a foreign country, but you do have to let the tax agency know if you sold the home and report any gains or losses on Schedule D of your U.S. tax return.
Keep all property-related documents available so you'll have proof of earnings and any costs you invested in improvements.
Here are some other tips:
If a home you inherited is worth more than $100,000 and the person you inherited it from wasn't a U.S. citizen or resident, you'll be obligated to file Form 3520: Reporting Foreign Trusts, Inheritances and Gifts for Americans Abroad.
The local taxes and laws in your second home's country will significantly impact your home purchase. Many countries require you to purchase your new home as a holding corporation rather than in your own name.
You may have to pay a transfer tax — from 1% to 10% — if the home belonged to someone else.
Mortgage interest may be deductible on your U.S. tax return, depending on whether you use the second home as your primary residence or as an investment property. Did you purchase the house in a currency other than U.S. dollars? You'll need to report that on your tax return, converting the currency to claim the deductions. If you lived in your foreign home during two of the previous five years, you could exclude up to $250,000 ($500,000 if married) from your taxes. Taxes you're paying locally can offset these gains.
Report to the IRS if the value of your foreign home has depreciated. The IRS depreciates foreign real estate with a different system than it uses for domestic properties. The depreciable life of foreign properties is between 30 and 40 years.
Take advantage of IRS rules
The IRS's Foreign Earned Income Exclusion program (FEIE) helps American expats reduce tax liability and avoid double taxation. To qualify, you must pass either the Physical Presence Test or the Bona Fide Residence Test. However, the gain you make from selling your foreign home won't qualify for the FEIE program because it's considered earned but passive income. But the sale of your home qualifies for Foreign Tax Credits, reducing your tax liability by one dollar for every dollar you've already paid in foreign taxes.
Consider both countries
Draft and execute your estate plan so that it's accepted in the U.S. and the country your second home is located in. It may be preferable to have separate wills to streamline the probate process. It's critical that your U.S. and foreign advisers coordinate their efforts to ensure one won't nullify the other.
Your U.S. estate plan may use trusts for tax planning, asset management and asset protection. And your U.S. will may provide all your assets be transferred to a trust. But be aware that many countries don't recognize trusts — this could mean higher foreign taxes or even obstacles to transferring assets. So, if you're buying overseas property, it is imperative you work with knowledgeable legal and financial professionals.