The allure of a foreign vacation home is simple. The surrounding wealth planning issues often are not.
From a villa overlooking the cliffs of Amalfi to a cabin in the wilds of British Columbia, the charms of international vacation homes are easy to understand. Yet a host of unique, sometimes complicated, tax and wealth transfer issues present themselves when acquiring a vacation home abroad. If, on your next trip outside U.S. borders, you feel inspired to make your stay a recurring one, there are several key tax and wealth transfer factors you will want to consider before making the purchase. We provide insight below.
As long as the foreign vacation home is owned under individual title – meaning you are the only owner and it was not purchased through a partnership, corporation, trust or other entity – and it is only used for personal enjoyment (not to produce rental income) it should not trigger U.S. income taxes unless and until it is sold at a gain. That being said, the country and local municipality where you purchased the home may impose a myriad of taxes, including property taxes, recording taxes and stamp taxes.
Yes. Mortgage interest paid on a foreign home can be deducted in the U.S. just as it can be deducted on a domestic home. In fact, the rules are the same for both U.S. and foreign homes. Currently, interest on up to $750,000 of principal is deductible as long as the debt was used to “acquire, construct or substantially improve” a primary residence or one other secondary residence of your choice. This rule is in effect for the years 2018-2025. For debt incurred, or homes under contract, before December 15, 2017 or after 2025, the principal amount is $1 million.
With changes implemented to the tax code by the Tax Cuts and Jobs Act of 2017, foreign real estate taxes are not deductible from 2018-2025. However, the itemized deduction for foreign real estate taxes is scheduled to return in 2026.
Foreign real estate may very well require a foreign estate plan, and we recommend that you work with a tax advisor and attorney to determine if you need a foreign plan. In the U.S., a will and testament is the foundation of estate planning, and we use revocable trusts to transfer real estate and other assets seamlessly when we die. The rest of the world does not play by these rules. Many countries, for example, do not have trust laws. So if you put foreign real estate into your U.S. revocable trust, it may have no significance to a foreign judge. Similarly, U.S. wills and testaments may not be recognized by local laws. In addition, a transfer of foreign property to a trust may in some jurisdictions trigger a tax.
Yes. The foreign country may impose gift, estate, inheritance and income taxes when you transfer your foreign real estate. The U.S. estate and gift tax calculation, meanwhile, includes the value of all your assets – including real estate abroad. It is possible that the U.S. estate tax system may give you a credit for foreign estate or inheritance taxes paid, but the credit is only available if the foreign tax is substantially equivalent to the U.S. estate tax. For example, save for treaty relief, the Canadian gains tax imposed at death would not generate a U.S. estate tax credit, because it is unlike the U.S. estate tax.
Fortunately, the U.S. has gift and estate tax treaties with 15 countries, Canada being one of them. These treaties generally allow both the U.S. and foreign country to tax the transfer of real estate, as long as the U.S. allows a credit for the foreign transfer taxes paid. Just remember that, due to the way the treaties are structured, if the foreign transfer taxes are higher than the U.S. transfer taxes, you will have to pay the higher foreign amount.
Next Steps When Meeting With Your Tax Advisor and Attorney
- Review the 15 countries with which the U.S. has gift and tax treaties here.
- Work with your advisors to assess the tax laws imposed by national and local authorities in the country where you own your vacation home.
- Work with your advisors to assess whether you need a foreign wealth transfer plan in addition to your U.S. plan. If so, your advisors may recommend you consult with tax and legal experts in the foreign country where your vacation home is located.
For more on the topics addressed in this story, read Accidentally Global: Tax Tips for International U.S. Families.