What a US person should be aware of when owning UK property
As most people know, the US allows a mortgage interest deduction on an individual’s tax return if the debt is secured by a qualified home. A qualified home is generally defined as your main home or second home. Mortgage interest is generally deductible on (1) mortgages taken out to buy, build or improve your home (otherwise known as home acquisition debt) in the amount of $1 million or less ($500,000 or less if married filing separately) and (2) mortgages taken out other than to buy, build or improve your home (known as home equity debt) in the amount of $100,000 or less ($50,000 or less if married filing separately). If the deductible mortgage interest, along with other allowable itemised deductions (such as real estate taxes, personal property taxes, state income taxes, charitable contributions, etc.) are higher than the applicable standard deduction for the year, then it will generally be beneficial to itemise deductions for the year.
The UK doesn’t have a similar mortgage interest deduction allowable for non-investment properties. As such, it is a common question as to whether mortgage interest is deductible on a foreign residence. In general, the answer is that it may be deductible. The rules around foreign mortgage interest deductions are the same as the rules outlined above for a US property. So, holding a mortgage on your UK residence may provide a benefit from a US perspective if you have taxable income in the US that is not off-settable by foreign tax credits. Not only can you potentially reduce your US taxable income further but you can sometimes receive a financial benefit if you are able to invest available capital and earn a return above that of the after-tax interest rate you pay on the mortgage loan itself.
One very important area to be aware of when holding a mortgage on a foreign property is around foreign currency. Most people know that if, at the time of sale, the property qualifies as the individual’s principal residence under certain IRS definitions then each owner is entitled to receive a $250,000 gain exclusion on the sale before any US tax applies. The fluctuation of foreign currency exchange rates can have a large impact on the recognition of gains upon disposal of real property. The exchange rate on the date of purchase and the date of sale are used to determine the taxable gain in local currency.
When a mortgage is paid off on a foreign property, the owner also must calculate whether there has been a gain or loss on the disposition of the mortgage due to exchange rate fluctuations. If a mortgage costs less at settlement due to the exchange rate at sale and the date the mortgage was obtained, the portion of gain recognised on the mortgage repayment is taxed at ordinary income tax rates. Without careful consideration of the currency fluctuation over the period of ownership, a taxpayer can sometimes unknowingly create large gains in local currency.
For more wealth planning tips and tidbits from MASECO read our 39 Steps to Smart Living in the UK.
Risk Warnings and Important Information
The above article does not take into account the specific goals or requirements of individual users. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.
MASECO LLP trading as MASECO Private Wealth is authorised and regulated by the Financial Conduct Authority, the Financial Conduct Authority does not regulate tax advice. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this document.