Recent first time (home) buyers - foreign exchange gains and capital gains

Wife (US+UK citizen) and I (UK citizen) have recently bought our first home together in the UK in December as Joint Tenants. It's a freehold. It's our principal (and only) residence and property. Purchase price was approx £230k. Mortgage loan was approx £200k. We're on a 7 year fixed rate mortgage. We had a gift from my parents of around £5k to help with the deposit.

Otherwise, we have relatively unexciting finances. She earns about £25k per annum. I earn about £50k per annum. Both full time salaried employees. We have meagre emergency cash savings (less than £10k atm) and we both pay into Local Government Pension Scheme. That's it. We've not had to pay any tax from the UK to uncle Sam in previous years because of Foreign Earned Income Exclusion.

We purchased as Joint Tenants without fully understanding the tax conundrum (but understanding the other reasons a couple might want to purchase in this way).

This will be the first time for filing taxes since purchasing the house. My wife reports as "married filing separately".

I understand that there are (I think) two main tax liabilities to think about relating to the property but I also have a question about our gifted deposit.

Gifted deposit

The gift of £5k from my parents was given to both of us without any kind of declaration of trust. I assume my wife needs to report this somewhere in this year's return. How much would she need to report of that gift, the whole £5k or just £2.5k (assuming the gift is a 50:50 split between us).

Foreign exchange rate gains

First of all - isn't this some complete BS?!?!? (rhetorical question)

Ok. So I understand basically what's going on here. If the $:£ exchange rate increases over the term of the loan the IRS reckons we've made some phantom dollars. Thank God that a certain person/lettuce + friend *bleep*ed the exchange rate at the end of last year (sarcasm).

I have a few questions here.

1) At what point do any "gains" resulting from exchange rate changes need to be reported? Specifically, practically for us, do we have to calculate this each year based on our regular monthly mortgage repayments and the balance on the mortgage, OR does she only have to report this when for example we're effectively repaying the mortgage when we remortgage/sell the house?

2) If there is any foreign exchange rate gains, can these be reported as regular income (alongside salary) and could they be covered by the Foreign Earned Income Exclusion? If not, what would be other primary sources of deduction for a regular Joe and Jane couple to try to mitigate against this sort of tax liability?

3) Is the whole of any foreign exchange rate gain on the entire property reportable for my wife, or is it just 50% (assuming the rest of the gains are mine)

Capital gains tax

So I understand that this is really a future issue to think about when we sell the property.  I understand that no capital gains is due in the UK. I understand that capital gains is an issue for US taxes but there's an allowance on primary residence. I understand that my wife would have an allowance that would almost certainly mean we wouldn't owe any capital gains tax. This is because the profit made on a house now worth £230k is unlikely to exceed the allowance unless weird things happen (although if we hold on to the house for decades it may not be so crazy...).

I believe that my wife would have a $250k exemption from any capital gains (because she's filing "married filing separately") but I don't know how much of the gains would be taxable because of my own stake over any gains. Would the whole of the gains from the sale be considered taxable as her gains, or would she only have to report 50% of the gains (her "share")?

I am not a tax pro but here are my thoughts.

Forget about reporting the gift. It is always the giver who has to report any gifts. That applies to the US and UK.

I don’t believe there are any forex gains to be concerned about unless or until you pay the loan off early. I would record the exchange rate on the day the loan started, converting the sum to USD so that if you pay off the loan in future, for example selling the house, then you calculate in USD how much the residual sum was and then there may be a capital gain to consider. For example suppose the initial £200k was $250k. In 10 years time you sell the house and the remaining mortgage was £100k, and the exchange rate was the same as 10 years ago so the value was $125k. This would mean no capital gain,  but in reality the exchange rate will have changed so you may have made a capital gain or loss.  Worry about this only when you sell.

The same goes for the sale of the house. Your wife’s portion is 50% and you calculate the initial cost of the house in USD and the sale in USD using the exchange rates on the day. All costs associated with the purchase and sale are deducted along with any capital improvements that have been made so keep good records. (Repairs don’t count but refitting a kitchen is a capital improvement) The sale and gain would be reported on her IRS return the year in which it is sold.

The OP is correct that one is supposed to keep track of the nominal dollar gains and losses on an annual basis while paying off a loan. If you are seriously rich, you'd need to pay attention to this. But none of us plebs bother with this and it seems the IRS does not expect it. How do we know this? There are hundreds of thousands of US taxpayers in the UK (and millions elsewhere). Many of them will have mortgages and yet none of them get chased for it.

The OP is correct that one is supposed to keep track of the nominal dollar gains and losses on an annual basis while paying off a loan. If you are seriously rich, you'd need to pay attention to this. But none of us plebs bother with this and it seems the IRS does not expect it. How do we know this? There are hundreds of thousands of US taxpayers in the UK (and millions elsewhere). Many of them will have mortgages and yet none of them get chased for it.

That sounds horrendous. For example if my mortgage owed was £200k at the start of the year, I paid £1,000 a month and at the end of the year I owed £198k then to calculate the capital gain or loss due to forex movements each month due the small repayment of principal would be very painful.

I think you are right that only seriously rich folks would need to be concerned.

That sounds horrendous. For example if my mortgage owed was £200k at the start of the year, I paid £1,000 a month and at the end of the year I owed £198k then to calculate the capital gain or loss due to forex movements each month due the small repayment of principal would be very painful.

I think you are right that only seriously rich folks would need to be concerned.

There is a $200 de minimis exemption - any forex gains under $200 don't need to be reported to the IRS. Unless you've got a whopping big mortgage, any gains on each individual repayment are likely to be under that exemption. It's typically only when repaying a mortgage in a lump sum (house sale, remortgaging, etc.) that the gains can easily exceed that $200.

Doesn't change the fact the whole thing is ridiculous...

There is a $200 de minimis exemption - any forex gains under $200 don't need to be reported to the IRS. Unless you've got a whopping big mortgage, any gains on each individual repayment are likely to be under that exemption. It's typically only when repaying a mortgage in a lump sum (house sale, remortgaging, etc.) that the gains can easily exceed that $200.

Doesn't change the fact the whole thing is ridiculous...

I don't think we are talking forex gains here, defined as gains while actively trading foreign currencies.  The changes in forex rates just happen to create a capital gain or loss when buying and selling assets.  I go through the same issues every year selling shares from my US ETF fund - the gain being quite different to HMRC than it is to the IRS. The cap gain in GBP is the proceeds in GBP of the sale on the day I sold them minus the cost of the shares in GBP when I bought them.  There is a big difference because when I bought the shares it was back in the days when the exchange rate was £1 = $1.6

$10,000 of shares was worth £6,250 at 1.6, and if I sold those same shares today for $12,000 there would be $2,000 in capital gains as far as the IRS was concerned but with the exchange rate now at 1.2 a capital gain of £3,750 to HMRC

As for the 5k gift, you'd be well under 3520 reporting, should the parents be NRA

I don't think we are talking forex gains here, defined as gains while actively trading foreign currencies.  The changes in forex rates just happen to create a capital gain or loss when buying and selling assets.  I go through the same issues every year selling shares from my US ETF fund - the gain being quite different to HMRC than it is to the IRS. The cap gain in GBP is the proceeds in GBP of the sale on the day I sold them minus the cost of the shares in GBP when I bought them.  There is a big difference because when I bought the shares it was back in the days when the exchange rate was £1 = $1.6

$10,000 of shares was worth £6,250 at 1.6, and if I sold those same shares today for $12,000 there would be $2,000 in capital gains as far as the IRS was concerned but with the exchange rate now at 1.2 a capital gain of £3,750 to HMRC

I think those are two different cases. 100% agree with your example for shares - had the same experience this year (in fact, some HMRC gains were IRS losses because of the exchange rates). Same would apply on the gain from a house itself, although the primary residence exclusion avoids this for most cases.

But the other "phantom currency gain" is all about the mortgage. A £100,000 mortgage at 1.6 USD to the GBP is a $160,000 liability. Drop to 1.2 USD to the GBP and you now only owe $120,000 - to the IRS, you've made $40,000, purely through forex. Even though in our currency of spending/saving, you still owe the same £100,000.

I think those are two different cases. 100% agree with your example for shares - had the same experience this year (in fact, some HMRC gains were IRS losses because of the exchange rates). Same would apply on the gain from a house itself, although the primary residence exclusion avoids this for most cases.

But the other "phantom currency gain" is all about the mortgage. A £100,000 mortgage at 1.6 USD to the GBP is a $160,000 liability. Drop to 1.2 USD to the GBP and you now only owe $120,000 - to the IRS, you've made $40,000, purely through forex. Even though in our currency of spending/saving, you still owe the same £100,000.

Agreed.

Fudge.

But would that 40,000 be a capital gain , or income?
And if its income, can you apply the foreign earned income allowance?

Wife (US+UK citizen) and I (UK citizen) have recently bought our first home together in the UK in December as Joint Tenants. It's a freehold. It's our principal (and only) residence and property. Purchase price was approx £230k. Mortgage loan was approx £200k. We're on a 7 year fixed rate mortgage. We had a gift from my parents of around £5k to help with the deposit.

Otherwise, we have relatively unexciting finances. She earns about £25k per annum. I earn about £50k per annum. Both full time salaried employees. We have meagre emergency cash savings (less than £10k atm) and we both pay into Local Government Pension Scheme. That's it. We've not had to pay any tax from the UK to uncle Sam in previous years because of Foreign Earned Income Exclusion.

We purchased as Joint Tenants without fully understanding the tax conundrum (but understanding the other reasons a couple might want to purchase in this way).

This will be the first time for filing taxes since purchasing the house. My wife reports as "married filing separately".

I understand that there are (I think) two main tax liabilities to think about relating to the property but I also have a question about our gifted deposit.

Gifted deposit

The gift of £5k from my parents was given to both of us without any kind of declaration of trust. I assume my wife needs to report this somewhere in this year's return. How much would she need to report of that gift, the whole £5k or just £2.5k (assuming the gift is a 50:50 split between us).

Foreign exchange rate gains

First of all - isn't this some complete BS?!?!? (rhetorical question)

Ok. So I understand basically what's going on here. If the $:£ exchange rate increases over the term of the loan the IRS reckons we've made some phantom dollars. Thank God that a certain person/lettuce + friend *bleep*ed the exchange rate at the end of last year (sarcasm).

I have a few questions here.

1) At what point do any "gains" resulting from exchange rate changes need to be reported? Specifically, practically for us, do we have to calculate this each year based on our regular monthly mortgage repayments and the balance on the mortgage, OR does she only have to report this when for example we're effectively repaying the mortgage when we remortgage/sell the house?

2) If there is any foreign exchange rate gains, can these be reported as regular income (alongside salary) and could they be covered by the Foreign Earned Income Exclusion? If not, what would be other primary sources of deduction for a regular Joe and Jane couple to try to mitigate against this sort of tax liability?

3) Is the whole of any foreign exchange rate gain on the entire property reportable for my wife, or is it just 50% (assuming the rest of the gains are mine)

Capital gains tax

So I understand that this is really a future issue to think about when we sell the property.  I understand that no capital gains is due in the UK. I understand that capital gains is an issue for US taxes but there's an allowance on primary residence. I understand that my wife would have an allowance that would almost certainly mean we wouldn't owe any capital gains tax. This is because the profit made on a house now worth £230k is unlikely to exceed the allowance unless weird things happen (although if we hold on to the house for decades it may not be so crazy...).

I believe that my wife would have a $250k exemption from any capital gains (because she's filing "married filing separately") but I don't know how much of the gains would be taxable because of my own stake over any gains. Would the whole of the gains from the sale be considered taxable as her gains, or would she only have to report 50% of the gains (her "share")?

You are correct that your spouse will file her US income tax returns each year in accordance with US law.  This might include reporting any US taxable foreign currency mortgage gain. I find this article very helpful: https://hodgen.com/when-buying-a-home-is-a-forex-transaction/

Fudge.

But would that 40,000 be a capital gain , or income?
And if its income, can you apply the foreign earned income allowance?

I’m afraid I don’t know the answer, I’ve not been in that situation myself.

Fudge.

But would that 40,000 be a capital gain , or income?
And if its income, can you apply the foreign earned income allowance?

Plunging deep into IRS training slides that I only half-understand: https://www.irs.gov/pub/int_practice_units/fcu_cu_c_18_2_1_04.pdf

But on slide 5, it sounds like any forex gain or loss based on a debt instrument, like a mortgage, would be "ordinary" - that is, taxed as income, not capital gains. That matches my understanding of part of the absurdity here - you pay tax on the phantom gain, but you cannot deduct a phantom loss.

Pretty far out on a limb here so don't just rely on me, but maybe that helps you get started.