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Non-Resident Sells Property Abroad, Becomes Resident - Do They Owe U.S. Tax?

Non-Resident Sells Property Abroad, Becomes Resident - Do They Owe U.S. Tax?
Ines Zemelman, EA
15-Jan-19

Situational analysis

A UK citizen (Mike B) purchased a home in the UK in 1998 for $100,000 USD, selling it 20 years later for $600,000, resulting in a capital gain of ~$500,000. Coincidentally, Mike moved to the U.S in July 2017 on an L visa.

 

 Questions to consider

1.    Does MIke owe any tax to the U.S?
2.    If Mike owes tax, on what amount is it calculated?
3.    What, if any, are Mike’s options to mitigate this unfortunate situation?

Cost Basis - is step-up an option?

What is Mike’s cost basis? Is it $100,000 (1998 cost), or can he use the ‘step up’ basis?

Step up basis, allows the taxpayer to ‘recalculate’ the cost basis not from the date of purchase, but from a new date in the future. Unfortunately, in general, this is not an option for a non-US person immigrating to the U.S.

  Some possible ways to plan the timing of income recognition include  
  1. Obtaining a step-up in basis before US residency begins by selling and reacquiring the house. It is a costly option because the owner would incur various transaction costs. However, if the property has had high appreciation it is the option to consider.
  2. Selling a foreign residence before US residency begins, to avoid US tax on any gain.
    This is the simplest option, if Mike is certain he does not want to hold this property any longer.
  3. The third option.

Remain UK tax resident - claim closer connection to foreign country

Publication 519 contains the following statement: "If you are treated as a resident of a foreign country under a tax treaty, you are treated as a nonresident alien in figuring your U.S. income tax." So, if he remains resident of UK, he can still be treated as an NRA (non-resident alien) in the U.S.?

 

  Steps to take  

1. Claim closer connections to the U.K on Form 8840 and file a non-resident return for 2018
2. In order to do so, Mike must spend less than 183 days in the US in 2018 and not to have applied for green card.
3. This combination Form 8840 + 1040NR may allow him to avoid reporting capital gains on the home.

Does not meet closer connection test- last option form 8833

If Mike has either spent too much time in the U.S., or applied for a green card (invalidating the form 8840 tests), a less reliable option is for Mike to file Form 8833 and exclude the sale of property as a treaty benefit while filing form 1040.

This is the last resort if  he does not qualify for closer connection through form 8840.
Form 8833 has this little loophole on Page 48 of Publication 519.
 

Reporting Treaty Benefits Claimed: You receive payments or income items totaling more than $100,000 and you determine your country of residence under a treaty and not under the rules for residency discussed in chapter 1.

If income from home sale was reported on 1042-s, 1099 or any other US form this claim would be impossible. But for a non-US property gain this may work.

Ines Zemelman, EA
Ines Zemelman, EA
founder of Taxes for Expats