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US Tax – UK Housing Photo courtesy Kingsley Napley LLP

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American tax payers and their family home in the UK
Jim Sawer (Kingsley Napley LLP) and Iain Younger (Frank Hirth plc) explore mortgages and exchange rates for Americans abroad
Published on June 26, 2018

An American Citizen or Green Card holder ("US Person") who is tax resident in the United Kingdom will still be required to submit a tax return in the USA and report worldwide income and gains.

Where income or capital gains are taxed in both countries, the tax paid by one country, with appropriate planning, can be offset against the tax payable in the other; to avoid double taxation.

But there’s very real financial pain for a US Person living in the UK when a tax free receipt here still falls to be taxed in the USA.

The most frequently encountered example concerns a sale of the family home in the UK.

If you are tax resident in the United Kingdom, the profit made on the sale of your main residence is free of Capital Gains Tax.

But the IRS taxes the gain made on the sale of the family home - whether it’s in London or Texas.

The first $250,000 of the gain is exempt but the excess can be taxed at up to 23.8%.

The $250,000 exemption depends on the property having been owned & used as your home for two out of the last five years of ownership – you can add the periods of use together. It does not have to be a continuous period of two years.

Where both owners are US Persons, they each have a $250,000 exemption; so joint ownership can make sense for US tax purposes.

If you are a US Person and your husband or wife is British, you’ve probably already twigged that, for tax purposes, it is better for the family home to be in their name. However, such a transfer must consider US Gift Tax issues.

The other financial problem is that the gain taxable in the United States will be calculated in dollars; both the purchase price and the sale price, paid in pounds, will need to be converted into dollars to work out the taxable profit.

A strong dollar on purchase and a weak dollar on sale can significantly increase the US tax bill. On the other hand, a purchase in 2007 when a pound would buy you two dollars could seriously reduce the US tax payable on a sale now (with the dollar comparatively strong).

Mortgages are irrelevant to the calculation of capital gains tax on sale in both the UK and the US, but, paying off a mortgage can have surprising, and potentially nasty, US tax consequences.

If a US Person buys a UK property with a sterling mortgage and the sum required to repay the capital in sterling, (when converted into dollars) is less than the dollar value at the time the loan was taken out, the phantom dollar "profit", produced purely by reason of exchange rate changes, may fall to be charged at regular US Income Tax rates of up to 37% (current rate).

The only "good news" is that while the UK long ago abandoned "mortgage interest relief" for income tax purposes, mortgage interest is still allowable for the purposes of US Income Tax.

With income tax payable in both countries and a mere offset of the smaller tax liability in one country against a larger tax bill in the other, this relief probably won't have any real financial impact; the "benefit" is, in truth, illusionary.

What to do? Apart from ensuring qualification for the $250,000 exemption and, if your spouse is British, making sure the family home is in his/her name, the answer is "not much" - and even if you stay alert to the impact of exchange rate movements, it’s tricky to engineer the exact right time for your property sale and mortgage redemption.

The authors are Jim Sawer, a Partner in Kingsley Napley LLP’s Private Client team, and Iain Younger, Director at Frank Hirth plc.

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