Understanding the rules
Under Internal Revenue Services (IRS) rules, a foreign mortgage repayment results in a foreign currency gain or loss, which can stem from several different types of repayment:
- Monthly capital repayments
- Ad-hoc repayments of capital refinancing or remortgaging i.e., paying one mortgage with another
To take an example, an individual takes out a £1,500,000 mortgage in 2018 when the exchange rate is £1:$1.33. They repay the mortgage in 2023 when the rate is £1:$1.28. In dollar terms, the initial loan was US$1,995,000, but the repayment is only $1,920,000. According to the IRS, there is a gain of US$75,000, which is reportable on the individual’s 2023 US tax return and taxed at 37%. US$27,750 of US tax is therefore due – although the taxpayer hasn’t received any money to incur this liability.
In practice, fluctuations in the exchange rate can result in a nasty surprise for taxpayers simply dealing with a mundane task. Moreover, while a gain is taxable, a loss is not allowable.
Considering the options to mitigate liability
Tax planning can help avoid such gains at the outset or mitigate the liability that arises.
There are various options to deal with a gain, which, depend on whether it results from a mortgage repayment or refinancing and whether the property is a personal residence or rental.
It is necessary to consider several issues:
- Whether there’s a way to avoid paying US tax on the gain.
- Whether the gain is US source or foreign source, and what basket of income it falls into, the taxpayer may be able to use excess foreign tax credits to offset it, provided they have enough to cover the liability.
- Any significant changes to the terms of the loan that may impact the options available.
The best solution will depend on the circumstances of the individual. Something as simple as a change in lender can significantly alter how the gain is dealt with and the options available. While refinancing may not always be practical, there may be ways to do so while minimising US tax exposure.
Contact the team for more information about refinancing or making capital mortgage repayments.
