The US tax benefits of owning foreign real estate

US investors can enjoy tax benefits on foreign real estate, whether it’s a second home in Tuscany or an investment property in Colombia

Dateline: Kuala Lumpur, Malaysia

This weekend, I’ll be hosting a mastermind event for a small group of my best private Members. And one of the big topics on the agenda is how to profitably invest in foreign real estate.

I’m a big fan of foreign real estate for a number of reasons from asset protection to profit potential. And I say that as someone who finds the real estate culture in many places annoying or downright nasty.

However, perhaps the biggest question mark when it comes to owning property overseas is how to deal with taxes. The country where you buy taxes ultimately has the final say over everything from stamp duties to property taxes to income tax when you earn rental income to capital gains taxes when you sell.

However, if you are a US citizen – or if you live in any country that taxes your worldwide income while living there – you should also be concerned about income and capital gains taxes in your country of residence, as well.

While US investors are at a particular disadvantage in that they can’t escape paying the IRS even if they stop living on US soil, there are also a number of US tax benefits for investors who wish to buy property in hot markets around the world.

Let’s examine a few…

1. No capital gains tax on foreign property used as a primary residence

Most people decide to actually live overseas – or at least travel as a perpetual traveler – before purchasing real estate overseas.

After all, it only makes sense to decide not only WHERE in the world you want to live, but what type of home you’d like to buy in your chosen city.

For US investors, the rules on capital gains taxes from personal residences are the same, no matter where the property is located. If you’ve owned US real estate (and actually managed to make a profit when selling), you are likely familiar with the tax law that allows you to exempt the first $250,000 in capital gains tax if single, and $500,000 if married.

To qualify, you must live in the house as your primary residence for 2 of the five years prior to selling it.

Just as many expats who qualify for the Foreign Earned Income Exemption enjoy a housing allowance to pay rent while living overseas, expats who own property overseas can avail themselves of the same tax break as those whose primary residence is in the United States.

A full $250,000 tax exemption for a single filer would save you around $60,000 in capital gains taxes… provided the country the property is in doesn’t tax capital gains.

It’s best to purchase property in a country that has a similar system of property taxation than the United States, since US tax law can’t offset or eliminate capital gains taxes payable where the property is. Countries like Panama have relatively low profits taxes on real estate sales and are worth considering.

Learn how to crack the code and legally pay zero tax while traveling the world.

Watch our Nomad Capitalist Crash Course.

The 1031 exchange on “like kind” property

Another popular tax benefit used by US real estate investors is the 1031 exchange for swapping one property for another “like kind” property. The idea is capital gains tax deferral.

We frequently talk about the power of compound interest and how it applies to offshore investing. You may remember from primary school that a penny doubled every day becomes $5,368,709.12 after one month. Quite an impressive return.

Yet deduct 30% capital gains tax from each day’s profits – starting at a mere $0.003 on the first day – and after one month your returns are not in the millions, but a mere $48,000 and change.

The lesson is that if you can’t eliminate taxes on your investment returns, deferring them is a preferable middle ground. Quite simply, paying tax on every transaction along the way can cost you a fortune.

Put another way, taxes on your investments are probably the difference between a luxurious oceanfront retirement and barely scraping by. That’s why the 1031 exchange program is so interesting; it allows you to defer capital gains tax by rolling your original principal and the return into a new property.

Just as US real estate can be used in a like-kind exchange, so can foreign real estate. The only rule to remember is that “like kind” is defined as either domestic or foreign property; the two can not be mixed.

That means that you can’t decide to sell your US rental properties and exchange them for rental properties in Chile or Cambodia; you can only exchange offshore property for other offshore property.

3. Owning foreign real estate in an offshore IRA

I’m known for suggesting that you don’t put money into an IRA or any other government retirement program. That’s certainly not professional tax advice, but rather my own personal opinion that – especially for the young – no government can be trusted with billions or even trillions of dollars in money that its owners aren’t supposed to touch for decades to come.

If you already have a retirement account, moving it to a cooperative custodian overseas can be your gateway to investing in all sorts of products your US custodian would never let you touch. Among those options: foreign real estate.

Of course, you can’t benefit from your own IRA. That means that, just as in the United States, you can’t buy a beachfront condo in Nicaragua and move right in. Terms like “self dealing” and “IRA” don’t go well together.

However, you can own foreign real estate in your government approved Self-Directed IRA, and you can enjoy ongoing rental income as well as capital appreciation.

Real estate held in your IRA is treated the same way other investments in your IRA are; it is taxed when you take the money out.

Of course, holding assets such as real estate in an IRA forces you to keep somewhat substantial assets in a government account. However, some lawyers believe that real estate is preferable to other asset classes as it is harder to confiscate.

While US real estate held in a foreign trust isn’t always the best idea (any judge can claim authority to invalidate the benefits of your foreign ownership), owning foreign real estate in a US government retirement account can have a lot of benefits.

4. Tax-deductible mortgage interest

If you plan to purchase a second home overseas for use while on vacation or as a future retirement home, you may be able to write off mortgage interest on up to $1.1 million in debt.

Now, not every countries’ system plays well with that of the United States, so it’s best to consult a US tax advisor before you add your second home’s mortgage interest to your tax return. The key here is that the rules are supposed to be the same whether your second home is in the Bahamas or Boston.

The biggest challenge of this may be actually getting a mortgage. Many foreign banks will not want to deal with expats, and certainly not at local loan-to-value rates. You may be able to get a foreign mortgage by putting down 30-50% on a property, or by obtaining developer financing if your property is a new build (although many new builds that are expat-friendly tend to be overpriced).

Additionally, things like depreciation and other homeownership expenses may or may not be deductible.

Learn how to crack the code and legally pay zero tax while traveling the world.

Watch our Nomad Capitalist Crash Course.

Nomad Capitalist is all about helping people like you “go where you’re treated best”. If you want to learn more about what exactly that means, and why I believe so strongly in it, I made this video that is worth watching:

Andrew Henderson

Andrew Henderson is the world's most sought-after consultant on legal offshore tax reduction, investment immigration, and global citizenship. He works exclusively with six- and seven-figure entrepreneurs and investors who want to "go where they're treated best". He has been researching and actually doing this stuff personally since 2007.
Andrew Henderson
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