The nasty smell at the back of your mortgage
The housing market is moving again and this will inevitably result in an increase in the number of mortgages being repaid.
Most individuals whose tax affairs span both the United Kingdom and the United States may feel relatively at ease with the tax consequences of selling their main home in the UK; the combined effect of the Principal Private Residence rules in the UK together with the Section 121 rules in the US, mean that those individuals who meet the requirements can receive a capital gain (limited to between $250,000 and $500,000 for US purposes, depending on your filing status) free of tax in either jurisdiction.
However it would be premature to end on that happy note, as there may be a sting in the tail for US taxpayers, resulting from the repayment of a non-US mortgage – a regular occurrence when a UK home is sold.
Section 988 transactions are foreign currency transactions including becoming a borrower under a foreign mortgage. Under the US law predating section 988, the borrowing and repayment of the mortgage loan is a separate transaction from the purchase and sale of the personal residence. The repayment of the mortgage constitutes a closed and therefore, taxable transaction. If the loan increases in value against the dollar between the time of the original borrowing and the time of the loan repayment, the amount of dollars required to retire the debt would be less than the dollar value of the amount originally borrowed. Therefore, a gain is recognised on the loan repayment. We can of course consider capital repayments made during the life of the loan when calculating the taxable income in relation to the transaction.
Below is an example of how we commonly see this in practice:
A property is purchased in December 2005 for £500,000 with a £250,000 interest only Sterling mortgage. The property is then sold in 2013 for £600,000 and the £250,000 mortgage repaid. No capital repayments are made during the life of the loan.
|Approx. Mortgage Valued in £||250,000|
|Exchange Rate at 16/12/2005||1.9267|
|Approx. Mortgage Value in $||481,675|
|Approx. Mortgage Value in £||250,000|
|Exchange Rate at 07/07/2013||1.4877|
|Approx. Mortgage Value in $||371,925|
|Foreign Exchange Rate Gain||109,750|
|Tax Charge at Marginal Rate of 28%||30,730|
There will be some who might take solace in the fact that the example could have examined a different period of ownership and the exchange rates would have resulted in a loss. In those circumstances, it is correct that no section 988 gain would be taxable. However whilst income, if any is taxable, a resultant loss is not recognised for the purposes of these rules.
The issue of taxable income on redemption of a mortgage has been the source of many difficult conversations over the past few months and we have nothing but empathy with those clients having to find funds to pay often unexpected liabilities resulting in this way. This is particularly the case when the mortgage has been redeemed but the property has not been sold as it can be difficult to find the funds to pay the resultant tax liability where no proceeds have been generated.
Often however, there are choices that can be made or planning put in place in anticipation of a sale and Tax Advisory Partnership are as always happy to discuss with new and existing clients, ways to mitigate tax liabilities arising from section 988 gains, as part of their wider tax strategies. We would encourage anyone who may be subject to the issues discussed above to contact us prior to settling their mortgage. As such, if you are a US taxpayer thinking of selling your property, renegotiating or redeeming your mortgage please contact us for advice.
Please contact the US Team on 020 8037 1100 or via email at email@example.com.