TAXING ISSUES Cross-Border Tax Impact Of Gain From The Sale Of A Personal Home In The United Kingdom The following is designed to provide general tax information for Americans residing in the United Kingdom and does not constitute legal advice. As with all legal issues, seeking tailored advice from qualified counsel is advisable. Considering a challenging and overly burdensome tax landscape, American expatriates living in the UK will be pleasantly surprised to find that owning a personal residence remains a relatively tax efficient investment. Many who own homes in the United Kingdom will be able to effectively shield gains from both US and UK tax by using the tax benefits in place. But the tax laws in both countries are not identical, and the protection provided in the United Kingdom through personal residence relief can be substantially more favourable than the sale of home exclusion benefit provided in the United States. The result is that some American expatriates who have been able to generate significant gains from the sale of a personal home in the United Kingdom could be facing a US tax bill. Given the tremendous performance of the UK real estate market in recent years, many American expatriates are in fact finding themselves in a position where the tax benefits in place for homeowners in the United States do not offer adequate protection. To complicate matters, the dynamic exchange rate between the US dollar and the Pound sterling over the past decade can also have the potential to materially impact tax attributes and create difficulties with UK mortgages. For American expatriates who own or are considering purchasing a personal home in the United Kingdom, this article will provide a brief overview of the cross-border tax framework you will encounter and explain how the US tax treatment of foreign currency fluctuations can turn a foreign mortgage into a tax trap. To illustrate these rules, we’ll consider the following scenario: • Elaine and John are American citizens who moved to London in 2011 and purchased a flat for £500,000, financing it with a mortgage of £300,000. The exchange rate at that time was £1 : $1.65. They paid a stamp duty tax of £10,000 when the home was purchased and made no significant improvements • In 2021, after having lived in the property for over ten years, they accepted an offer to sell 12
AMERICAN IN BRITAIN
for £1.1 million. The outstanding balance of their mortgage at that time was £100,000 and the exchange rate was £1 : $1.37 • Elaine and John are both taxed in the United Kingdom as residents and they file a joint federal tax return in the United States. The taxable income reported on their 2021 US tax return before any gain from the home sale was $280,000.
Under personal residence relief provisions, there is generally no limit on the amount of gain that can be protected from capital gains tax
Given that Elaine and John have lived in the London flat for their entire period of ownership, they would qualify for full personal residence relief and would not be subject to capital gains tax in the United Kingdom from the sale.
US Tax Guidelines For Homeowners
Sale of Home Exclusion As a general rule, American taxpayers who have owned a residence that has been their main home during at least two of the five years prior to the sale will not be taxed on the first $250,000 of gain produced. This exclusion is doubled to $500,000 for married taxpayers filing a joint tax return, but periods of non-qualifying use that occurred in the five-year testing window prior to the two-year test being satisfied can result in a reduction of the eligible threshold. The exclusion is available in full to Americans who reside overseas and own foreign property. For Elaine and John, as they have owned and lived in the London flat for more than the two-year requirement, they would qualify for the full $500,000 exclusion available to married taxpayers filing jointly. However, given that the gain produced from the sale will likely exceed this threshold, tax will still need to be calculated for US tax purposes.
Currency Fluctuations UK TAX GUIDELINES FOR HOMEOWNERS Personal Residence Relief
Broad relief exists in the United Kingdom protecting homeowners from capital gains tax. To qualify for full relief, the property must have been a main home for the entire period of ownership, not been used for trade or business purposes, and not acquired as an investment. Limitations are also in place for properties larger than 5,000 square meters. Under personal residence relief provisions, there is generally no limit on the amount of gain that can be protected from capital gains tax. And when periods of nonpersonal use have occurred subsequently, the portion of the gain allocable to the period of time the property was a main home will still be eligible for limited relief.
For US tax purposes, the sale of an asset will always need to be reported in US dollar terms. Therefore, when property is acquired outside of the United States, fluctuations between the dollar and the currency in which the transaction is denominated will be factored into the gain or loss calculations. Accordingly, in scenarios where a currency has fluctuated significantly against the US dollar during the period of ownership, a material impact on the gain or loss calculated from the sale of the property will result. To figure the gain or loss from the transaction, the purchase price is converted to US dollars using the exchange rate in effect on the date the property was purchased. The sales proceeds are then converted using the rate in effect on the date of sale. Any capital improvements to the property would be added to the cost and converted to US dollars using the effective rate on the date the expenses were paid.
