4 May 2021
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Why UK mortgages can lead to tax liabilities for US citizens

By Michael Lewis

Partner, Private Client Services, EY Frank Hirth Limited

Provides complex tax planning and compliance advice to international ultra-high-net-worth individuals. Passionate about cycling. Enjoys spending time with family and travelling.

4 May 2021
Related topics Tax

Remortgaging in the UK can be complicated for US taxpayers, with exchange rates creating on-paper gains and unexpected payments.

In brief
  • Exchange rate movements can create unexpected tax liabilities on repayments and remortgaging.
  • Professional advice may help to reduce or prevent the likelihood of liability on gains created.

In the aftermath of the pandemic and amid continuing economic uncertainty, many taxpayers will be reassessing their finances. A useful first step can be to consider remortgaging, to take advantage of current low-interest rates.

It is common for UK homeowners to remortgage their properties every two or five years. However, US citizens living in the UK may not know the potential consequences in terms of US tax. Refinancing or paying off a mortgage without considering the US tax implications can result in surprisingly large US tax liabilities, so understanding the US tax implications before remortgaging is key.

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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 2021 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 2021 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 EY Frank Hirth for more information about refinancing or making capital mortgage repayments.

Summary

Simply remortgaging or making capital repayments on a UK mortgage can prove expensive for US taxpayers. Careful planning is required to reduce the likelihood of liabilities.

Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Neither Ernst & Young LLP nor EY Frank Hirth Ltd accepts responsibility for any loss arising from any action taken or not taken by anyone using this material. If you require any further information or explanations, or specific advice, please contact us and we will be happy to discuss matters further.

About this article

By Michael Lewis

Partner, Private Client Services, EY Frank Hirth Limited

Provides complex tax planning and compliance advice to international ultra-high-net-worth individuals. Passionate about cycling. Enjoys spending time with family and travelling.

Related topics Tax