Depreciation for foreign rental property

Tax, SDIRAs & Cost Segregation
10yFollow

Depreciation for foreign rental property

Account Closed
Real Estate Investor · San Diego, CA · Member since 2016 · 1 post · 0 votes

I have a question regarding Canadian rental property for US taxes. As you know the foreign rental property is subject to a 40-year linear depreciation in US. Taking depreciation allows me to reduce my taxable rental income. But when I sell the property, the depreciation will be reduced from the property cost basis, and therefore, I would have to pay capital gain on it.

I was wondering, is it possible that I do NOT take any deprecation in my yearly taxes, and similarly, do not reduce anything from my cost basis when selling the foreign rental property for US taxes?

I have read in one of IRS publication that even if we do not take the depreciation as an expense to reduce our yearly taxable rental income, we have to include the allowable depreciation in the cost basis when we sell the renal property and pay capital gain for that. Is there any way around this for foreign rental property? I really don't like the depreciation headache although I understand it is useful when done right. In Canada, there is really no land and building value separation, so this is all more paper work!

0Reply
22 views

2 Replies

Jump to latestLatest
  • Dave Toelkes
    Investor · Pawleys Island, SC · Member since 2008 · 1k+ posts · 837 votes
    10y

    Just speaking to the tax treatment on depreciation for US taxpayers.  You are correct that when the property is sold, the IRS will tax you on the amount of depreciation that you should have taken but did not.  This usually works out to the same after tax income as you would have had without taking the depreciation in the first place but only if there is no tax on the depreciation you should have taken.

    The purpose here is to recover the tax you did not pay on depreciation that did not take place.  For example:  Buy a property for $100K and take $20K in depreciation during your holding period.  The book value for the property is now $80K.  If you sell the property for any more than $80K, then some or all of the depreciation did not happen and the income tax savings that you received from the depreciation that did not happen is "recaptured" when the property is sold.  In this example, let's say you sold the property for $120K.  The sale price minus the book value gives you a $40K profit ($120K - $80K).  You have $20K in capital gain due to appreciation and $20K in capital gain due to depreciation.  Since the depreciation did not really take place, the portion of your capital gain due to depreciation is taxed as ordinary income to recapture the tax that you did not pay when you took the depreciation expense.  The portion of the capital gain due to appreciation is taxed at the applicable long term capital gain rate, which may be less than the tax rate on the unrecaptured depreciation.

    If you don't take the depreciation that you should have taken, you do not benefit from a lower ordinary income tax on your rental income AND you will still be taxed on the depreciation that you should have taken.  Failure to take the depreciation expense effectively taxes that portion of your rental income twice.  

    So, I hope you see that you really want to take the depreciation expense that is allowed.  I am not aware of any exception for foreign rental property.  

    1Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    10y

    You are technically requirement to depreciation property that is held for rental, investment or business use, and the IRS WILL still assess depreciation recapture in the future even if you have not taken any deductions on your income tax returns for depreciation.  You generally end up hurting yourself if you do not take the depreciation because they will recapture it eventually unless you continue to 1031 Exchange through out your lifetime ... never sell and cash out and pay the taxes ... and leave the property to your heirs who end up receiving a step-up in cost basis.

    Exeter 1031 Exchange Services, LLC and Exeter Trust Company4.726 Reviews
    WebsiteView Page
    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free