Tax Talk Thursday: U.S. Tax Treatment of Foreign Rental Properties

Owning a rental property abroad can be both rewarding and complicated—especially when it comes to U.S. taxes. The United States taxes its citizens and residents on worldwide income, which means rental income from a property outside the U.S. must be reported on your U.S. tax return. Whether you own an apartment in Tokyo, a villa in Italy, or farmland in Mexico, the rules apply the same way: if you earn income, the IRS wants to know about it.

In this blog, we’ll walk through the key issues U.S. taxpayers should understand about foreign rental properties.

Reporting Rental Income

Foreign rental income is reported on Schedule E (Supplemental Income and Loss) of your Form 1040, just like domestic rental properties. You must include all income earned from the property, even if it never comes back to the U.S. or stays in a foreign bank account.

Rental income includes:

• Monthly rent payments

• Advance rent

• Security deposits kept (if not returned)

• Any payments in exchange for the use of the property

  
  

Deductible Expenses

You can deduct many of the same expenses as you would for a U.S. property, including:

• Mortgage interest (subject to foreign financial reporting rules)

• Property taxes paid to a foreign government

• Repairs and maintenance

• Management fees

• Insurance

• Utilities (if you, not the tenant, pay them)

• Depreciation

  
  

Depreciation of Foreign Property

Here’s a big difference: while U.S. residential property is depreciated over 27.5 years, foreign residential rental property is depreciated over 30 years (straight-line method). Commercial foreign property generally uses a 40-year depreciation schedule.

Foreign Taxes Paid

If you pay property tax or income tax to a foreign government on your rental income, you may qualify for a foreign tax credit (Form 1116) or an itemized deduction. The foreign tax credit is usually more beneficial, since it directly reduces your U.S. tax liability and helps avoid double taxation.

Currency Exchange Considerations

All income and expenses must be reported in U.S. dollars. This means you’ll need to use the IRS’s prescribed exchange rates (often average annual rates) when converting foreign rent collected and expenses paid.

Foreign Bank Account Reporting

If rental income is deposited into a foreign bank account, you may also have to file additional forms such as:

• FBAR (FinCEN Form 114) if the total of all foreign accounts exceeds $10,000 at any point during the year

• FATCA (Form 8938) if your foreign assets exceed certain thresholds

These are separate from your tax return and carry significant penalties if missed.

Passive Activity Loss Limitations

Just like U.S. rental real estate, foreign rental losses are considered passive activity losses. In most cases, these can only offset other passive income. However, up to $25,000 of losses may be deductible against non-passive income if you actively participate and meet income thresholds.

Special Considerations

• Local rules: Some countries may impose restrictions on foreigners owning or renting property. Always coordinate with local professionals.

• Treaty benefits: Tax treaties may alter the treatment of certain items, so review whether your country has a U.S. tax treaty.

• Exit strategy: If you sell the property, you must also report the gain (or loss) on your U.S. return, including currency fluctuations that can increase taxable gains.

  
  

Foreign rental property ownership is an excellent way to diversify investments, but it comes with complex reporting requirements. Proper planning can help you maximize deductions, avoid double taxation, and stay compliant with the IRS. If you need help with your US tax obligations, reach out to us at info@mkhstaxgroup.com.