The nasty smell at the back of your mortgage
The London housing market is booming again and inevitably this results in homes being sold and mortgages being repaid.
Most UK taxpayers, including those who happen to be US citizens, will be aware of the Principal Private Residence rules that provide an exemption from UK tax on the sale of their main home in the UK. However, if you are a US citizen this may not be the end of the story.
The IRS requires US persons to report their worldwide income and gains annually, regardless of where in the world they might be living. As a result, Americans residing in the UK need to consider not only HMRC’s view of the sale of their UK home but also the US tax consequences. As London Mayor, Boris Johnson discovered recently, when a US citizen (which he was by birth) sells their UK home, Capital Gains Tax ("CGT") applies in certain cases when an asset is sold for more than it was originally purchased. The taxable gain (profit) may be triggered following the transfer of an asset, although commonly this would follow a sale. A number of tax reliefs are available to exempt or reduce the tax that may apply. Basic tax planning may... More may nevertheless be due to the IRS.
There are exemptions which can allow up to $250,000 of the resultant gain to be excluded from US tax (up to $500,000 for a joint return with a spouse) and Tax Advisory Partnership can advise on these. Qualification for exemption depends upon the amount of time the property has been owned and how long it has been used as the main home.
It might seem bad enough that the UK will exempt the sale of the main family home but the IRS may continue to subject that sale to US tax but there may in fact be an additional sting in the tail for US taxpayers. This nasty smell at the back of your mortgage results from the repayment (or refinance) of a non-US dollar mortgage, which usually happens when a UK home is sold.
With apologies for citing the technical references, section 988 of the Internal Revenue Code deals with foreign currency transactions and includes becoming a borrower under a foreign mortgage e.g. a GBP mortgage to buy a home in the UK. Under the US law predating Section 988, the borrowing and repayment of a mortgage loan is a separate transaction from the purchase and sale of the property. The repayment of the mortgage constitutes a closed and therefore, taxable transaction and as such there are usually tax consequences for a US person who redeems their UK mortgage or indeed any other non-US dollar loan.
Whilst the particular focus of this article has been on UK private residences, the type and location of the property is irrelevant and these foreign currency transaction rules will apply equally to mortgage loans used to buy investment property, holiday homes and commercial premises, wherever they are situated. Whether or not there is a US tax liability will depend on how the dollar has moved against the currency of the foreign mortgage. As a general rule, if the dollar cost of repaying the foreign loan has reduced between the time of the original borrowing and the time of the loan repayment, there will be a gain.
Any capital repayments made during the life of the loan must also be considered and this can add further complication. Unfortunately, whilst a gain would be taxable, any resultant loss is not recognised for the purposes of these rules.
This issue of taxable gains arising on redemption of a mortgage is not widely known and has been the source of many difficult conversations with clients. We have nothing but sympathy for those having to find funds to pay often unexpected liabilities, particularly where a property has been remortgaged to take advantage of falling interest rates but the property itself has not been sold.
Often however, there are choices that can be made or planning put in place in anticipation of the sale of a home or the redemption of a mortgage. At Tax Advisory Partnership we regularly advise clients on legitimate ways to mitigate tax liabilities arising from section 988 gains or from the sale of their homes and other properties, as part of a wider review of their tax strategies.
We would encourage anyone who is or believes they might be regarded as a US citizen, to take advice well in advance of the sale of any property or the redemption of any non-US dollar mortgage or other loan. Similarly, historic transactions should be considered and disclosure made to the IRS if appropriate. At the very least we can help you understand whether and to what extent there may be a liability and what choices may be available in terms of planning or managing the process with the IRS.
As with any lingering nasty smell, there is no real alternative other than to roll up your sleeves and tackle the problem before it gets worse. We are always happy to discuss specific issues with potential new US clients in confidence and without obligation.