Sale of house - foreign currency gain on mortgage?

Hi all,

I am a dual UK-US citizen, permanently residing in the UK with no US assets. Obviously I file US taxes each year, but using FTCs I do not owe any tax to the IRS, and have no investments or other fancy things that would heavily complicate my filing.

However,  I am now trying to understand the implication of the sale of my home. I have 1 house as primary residence, a number of years ago took a mortgage out for £137,500 when the exchange rate was around 1.565 USD/GBP.

In selling my property the mortgage is redeemed in full and the remaining amount is around £85,000 with the exchange rate being 1.294 USD/GBP.

Firstly, I am MFJ and the gain on the property is minimal, nowhere near the threshold ($500,000) for taxable. Is it reportable though? Do I fill out any forms stating this information to report the sale of my property and that I am exempt from any gains tax as primary residence and lived for >2years in?

Secondly, how do I work out, and subsequently report the gain due to foreign exchange rates? I am quite scared of this, as my understanding is that you would take the amount remaining on the mortgage at the original exchange rate, and subtract the same amount converted to USD at the prevailing rate when redeemed.

E.g. :
£85k x 1.565 = $133,025
£85k x 1.294 = $109,990

Difference = $23,035 (a taxable gain??)

Is this the correct way to figure the foreign exchange gain? Is there anyway to reduce this? What it the rate of tax on this and how is it reported? By my estimations I could have at minimum $3,500 tax to pay on this...although no clue on figuring it out (assuming long term capital gains tax rate?).

Any thoughts or advice, including the justified rants about how insane and unfair the rules in regard to this scandalous tax are, appreciated.

Many thanks in advance.

Following because this is something that concerns me. But it looks like you may have had a loss? The current value in USD of £85k is much less than it was at the time of your purchase.

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Logic might dictate that, but it needs to be thought about in the context of the loan.

If you borrowed £100k at an exchange rate of 1.5, you have to repay $150,000.

If the exchange rate is now 1.2, you would have to only repay $120,000.

Therefore, in the "eyes of the IRS", I guess, you have actually gained $30,000 as you have benefited from the currency rate change. If the rate had gone up,  e.g. to 2, you would (on conversion to USD) actually be "worse off" as you would have to repay $200,000 instead of the original $150k. Therefore this would be a "personal loss" and not deductible.

This is a ticking time bomb for many US expats in the UK. In theory, if you remortgage or make a large repayment of your mortgage, you would even in those cases be subject to a CGT if the exchange rate was significantly different. So let's say you took a mortgage for £350k out 5 years ago when exchange rates were 1.5. You fixed in for a 5-year fixed rate and so now you look to remortgage. You change lender, and so there has been a redemption of your old mortgage, let's say it is £320k left. If my above calculations are correct and you use £320k as the amount, that is (£320k x1.5) - (£320k x 1.2) = $96,000 which would be subject to US CGT in theory.

Yes, this is madness. But that is how I understand the way the rules view this.

https://www.ingletonpartners.com/insights/the-us-taxation-of-a-mortgage-foreign-exchange-gain/
https://www.taxential.com/en/publications-mortgage-fx-gain/
https://blog.taxadvisorypartnership.com/blog/us-tax/foreign-mortgage-exchange-rate-gain

I would love for someone to be able to show me where/that I am wrong on this. It truly is insane that you are penalised for exchange rate change when you are simply trying to live in a primary residence...

The following is my understanding, and may or may not be correct.

I would love for someone to be able to show me where/that I am wrong on this.

Unfortunately, you are not wrong. IMO, what you have detailed in the 2 posts is correct.

Normally, the default position is for the gain to be assessed as ordinary income and taxed accordingly,  BUT, I understand substantial authority exists for the gain to be treated as a capital gain. I don't know any details.

It's also my understanding that the tax due on the gain can be offset by the use of excess FTCs (1116) from the past 10 years. The proviso, of course, is that you have been using 1116 in the past and have an accumulation of excess passive FTCs. (I'm assuming it's passive - I could be wrong.)

Not that it will affect you, but additional NIIT (Net Investment Income Tax) also can come into play (the Obamacare tax) if the total gains on your return exceed the threshold. NIIT can not be offset by FTCs.

I'll make no further comments on the ethics of this, or how one should approach declaring it. Enough said?

Thanks theOAP, very helpful.

Sad to hear that I am not incorrect though. Reading US code 988 more, I'm now starting to doubt the ability to call this capital gains, and benefit from long term rates of 15% tax, but actually it reads to me as ordinary income which obviously means the tax bill becomes much higher if declared. If you read Greenbacktaxservices though (https://www.greenbacktaxservices.com/blog/expat-taxes-buying-selling-real-estate-abroad/), where they say:

"Effects of the Exchange Rate
The other important transaction likely to result from the sale of a foreign residence is the gain or loss resulting from the foreign exchange rate conversion when the mortgage is paid off. The currency exchange gain or loss resulting from the payoff of the mortgage is considered personal. Thus, any resulting loss is not deductible. However, any resulting gain is taxable at ordinary income rates. If you have held the property for at least a year, you will qualify for the lower long-term capital gain tax rates. Unfortunately, you cannot use the loss on the sale of the home to offset any currency exchange rate gain and vice versa."

I don't understand the wording there and how they switch from the mortgage back to the sale of a house. Seems confusing to me.

Personally, I have an absolute tonne of FTCs, but all in the general category. As in the UK, I am paying ~200% of the tax I would owe in the US each year, but it is all general category. I have no tax to credit in passive category. So if this sits in passive, (would be a hard sell to call it general category?! Or would it, as it is considered "ordinary income"??), I have nothing to cover it. All because of rate changes.

One does wonder, how even in an audit setting though, this would be an obvious finding. I can understand a rationale to tax foreign exchange gains, as this could be a loophole for some people. But to do it on a mortgage on a primary home where your residence and tax home is 100% in that foreign territory is certainly madness; and one could argue inherently unethical.

Reading US code 988 more, I'm now starting to doubt the ability to call this capital gains, and benefit from long term rates of 15% tax, but actually it reads to me as ordinary income which obviously means the tax bill becomes much higher if declared.

Have a read of the following link. It is from the BritishExpats site. These are Brits who moved to the States, but didn't sell their UK property until after they had arrived. It may seem unrelated, but the 988 problems they face are the same as those for us who are US expats in the UK. Pay particular attention to reply #12 from Cook_County. A professional, I believe, who also posts on UK Yankee under a different user name. While a few points refer to US residence, I trust the other comments are based on real world expertise and worth noting since they are tax declaration specific and would also apply to USCs in the UK.

https://britishexpats.com/forum/usa-57/us-tax-due-sale-uk-home-currency-fluctuation-853095/

You asked a question in your first post regarding reporting of the sale of the property. It is my understanding if the net gain from the sale of the house is below the applicable exclusion amount ($500k in your case - MFJ), and thus there is no reportable gain, there is no obligation to report the sale on a 1040 return.

Personally, I have an absolute tonne of FTCs, but all in the general category. As in the UK, I am paying ~200% of the tax I would owe in the US each year, but it is all general category. I have no tax to credit in passive category. So if this sits in passive, (would be a hard sell to call it general category?! Or would it, as it is considered "ordinary income"??), I have nothing to cover it. All because of rate changes.

If the mortgage had been handled on a QBU basis, the functional currency might have been designated as £sterling - but this is really out of my knowledge range.

I can understand a rationale to tax foreign exchange gains, as this could be a loophole for some people. But to do it on a mortgage on a primary home where your residence and tax home is 100% in that foreign territory is certainly madness; and one could argue inherently unethical.

I don't disagree, especially for the long term, permanent expat. 'Phantom' gains in this instance are unethical.  It's the reason many professionals encourage a USC married to a UKC couple to place any property only in the UKCs name.

Have a read of the following link. It is from the BritishExpats site. These are Brits who moved to the States, but didn't sell their UK property until after they had arrived. It may seem unrelated, but the 988 problems they face are the same as those for us who are US expats in the UK. Pay particular attention to reply #12 from Cook_County. A professional, I believe, who also posts on UK Yankee under a different user name. While a few points refer to US residence, I trust the other comments are based on real world expertise and worth noting since they are tax declaration specific and would also apply to USCs in the UK.

https://britishexpats.com/forum/usa-57/us-tax-due-sale-uk-home-currency-fluctuation-853095/

You asked a question in your first post regarding reporting of the sale of the property. It is my understanding if the net gain from the sale of the house is below the applicable exclusion amount ($500k in your case - MFJ), and thus there is no reportable gain, there is no obligation to report the sale on a 1040 return.

Thanks for this, the OAP, helpful as always. Most helpful as well to note your interpretation that no obligation to report the sale on a return. I think I need to think very carefully on the other aspects, as alluded to by the link provided.

If the mortgage had been handled on a QBU basis, the functional currency might have been designated as £sterling - but this is really out of my knowledge range.

Outside mine too, but fairly certain this would not apply; thanks though for raising.

I don't disagree, especially for the long term, permanent expat. 'Phantom' gains in this instance are unethical.  It's the reason many professionals encourage a USC married to a UKC couple to place any property only in the UKCs name.

Indeed! However, in a strange and unique twist to my life events, despite being born in the UK (to US parents who registered me as citizen born abroad), and spending most of my entire life in the UK, I met my wife in the UK and ironically she was a dual citizen as well (not planned). We only both realised about tax reporting obligations around 4-5 years ago, where I went down the OVDP route, filing the previous 3yrs 1040s and 6yrs FBAR plus the current year (we have no US assets, accounts, links except family). Learning a lot since, but this is the latest one that has come to my attention. I also now regret giving our 2 children USC / UK dual citizenship status from birth.....the accidental citizenship continues in our family!

Hi. 

You may be more experienced than I, but I just had my quite complex taxes done for 2019. For the  First time, I used a London professional due to inherited iras and paying off our uk mortgage.   Our tax guy did declare it as capital gains on the currency movement, however, in the end I had nothing to pay. 


I am primarily responding to your overall situation with the kids and a few things I wish I had known!  . I am a us citizen in the uk for 30 yrs.  2  near adult children with dual nationality and a uk husband.   For years (17) I filed it FEIE and called it quits.  I only sought professional advice when my parents died and I wanted to gift to the kids. 

I found out that I had financially advised my kids very poorly for dual nationals.   Share isas are not tax free and are punitively taxed.  All of our share investments are now set up on a usa and uk compliant platform.    Cash, sipps and employer pensions were fine.  Charitable giving is much more beneficial thru a dual national charity fund.  I am eligible for social security even though I left at age 21.   The inheritance was very straightforward on gifting and taking red distributions

I would have been much better off revoking the FEIE earlier it turns out and I would have received tax refunds.  I wish I had sorted this before I had to do it record time.  When my parents died in quick succession NO usa banks would host the inherited IRAs as I had only a uk address.  I was given 90 days to get the money out.  Without the professional advice I finally got in London with a dual qualified ifa, I would have lost so much in tax.  Just something to consider!   

Hi. 

You may be more experienced than I, but I just had my quite complex taxes done for 2019. For the  First time, I used a London professional due to inherited iras and paying off our uk mortgage.   Our tax guy did declare it as capital gains on the currency movement, however, in the end I had nothing to pay. 

That is interesting to know, it suggests to me that either you had passive FTCs to offset the gain or your accountant was comfortable using general FTCs.

I am primarily responding to your overall situation with the kids and a few things I wish I had known!  . I am a us citizen in the uk for 30 yrs.  2  near adult children with dual nationality and a uk husband.   For years (17) I filed it FEIE and called it quits.  I only sought professional advice when my parents died and I wanted to gift to the kids. 

I found out that I had financially advised my kids very poorly for dual nationals.   Share isas are not tax free and are punitively taxed.  All of our share investments are now set up on a usa and uk compliant platform.    Cash, sipps and employer pensions were fine.  Charitable giving is much more beneficial thru a dual national charity fund.  I am eligible for social security even though I left at age 21.   The inheritance was very straightforward on gifting and taking red distributions

I would have been much better off revoking the FEIE earlier it turns out and I would have received tax refunds.  I wish I had sorted this before I had to do it record time.  When my parents died in quick succession NO usa banks would host the inherited IRAs as I had only a uk address.  I was given 90 days to get the money out.  Without the professional advice I finally got in London with a dual qualified ifa, I would have lost so much in tax.  Just something to consider!

Appreciate your insights and taking the time to share! Early on when as an accidental citizen I realised I should file (about 5 years ago), I originally thought FEIE/2555 but then saw the benefit fortunately of FTCs and revoked FEIE. This has also played into my favour as I had 2 children who are dual nationals and so have USC status, despite being born and living all their lives in the UK. Pity for them in terms of long-term tax, but beneficial now as I can get $1400/child tax rebate each year from the IRS for the additional child tax credit. Slightly eases my pain of filing each year...

I chose not to touch ISA or stocks/shares etc for the complications with dual tax associated. I see no benefit of these and I am not rich enough to warrant trying to seek benefit! My one slight concern is that I have a number of stock options due to employment (not exercised or of any current value), that if the company I worked for got bought out, I would need to figure out how to deal with those. However I am hoping if that problem happened, it would be a good one to have as I would actually benefit a fair bit!

Take care and thanks again for the help!