u.s. expat tax guide – india
I’m selling property in India. What do I need to know?
If you’re a US citizen or Green Card holder and you sell property in India, you must report the sale to the IRS under capital gains. The US taxes your worldwide income, which means that any taxable event, like selling property, has to be reported to the IRS, even if it happened in India.
In India, when you sell a property, the capital gains tax is calculated using indexed pricing. Indexed pricing means adjusting the original purchase price for inflation, so it better reflects current market value.
This usually results in lower taxes in India, as the cost is adjusted to account for inflation over time.
However, in the US, the cost basis is simply the original price you paid for the property when you bought it. Because of this difference, you might end up with a higher capital gain to report in the US, which means you may owe more in capital gains taxes.
How can US citizens use the US$250,000 exclusion for property sales?
If you have lived in the property for at least two out of the last five years, you may qualify for the US$250,000 exclusion on capital gains.
This means you don’t have to pay tax on up to US$250,000 of the profit from selling your primary residence. If you’re married and filing jointly, this exclusion goes up to US$500,000.
For example, if you sell your property for a profit of US$400,000, you could exclude US$250,000 from taxation if you meet the requirements. You would only need to pay capital gains tax on the remaining US$150,000.
What property improvement expenses can US expats deduct?
Here are some of the property improvement expenses that US expats can deduct:
- Renovations to increase property value (e.g., kitchen or bathroom upgrades)
- Structural improvements (e.g., adding a new room or deck)
- Electrical and plumbing upgrades
- Roof replacements
- Landscaping enhancements that add value
- New flooring or windows
- Painting and other significant property upgrades
If you made improvements to the property, such as renovations to increase its value before selling, these costs can reduce your taxable profit. Additionally, selling expenses, such as real estate commissions, legal fees, and registration fees, can also be deducted.
For instance, if you sold the property at a profit of US$400,000 but spent US$50,000 on improvements and US$10,000 on selling expenses, you can subtract those costs from your profit.
This means your taxable gain would be reduced to US$340,000 before applying any other exclusions.
How does renting out a property affect capital gains taxes for US citizenship holders?
If the property was rented out and you did not live in it for two of the last five years, you won’t be able to use the US$250,000 exclusion. In this case, the gain on the property is fully taxable in the US, though you can still use other deductions to lower your taxable gain.
For example, rental properties are subject to depreciation deductions in the US. While renting out the property, you would have taken depreciation deductions each year.
When you sell, the IRS requires you to recapture this depreciation, which means that you must add back the depreciation amount to your taxable gain.
How does India tax rental properties compared to the US?
In India, rental income is taxed with a standard deduction of 30% on the gross rental income, and other specific expenses cannot be deducted. This differs from the US, where you can deduct depreciation and other property-related expenses.
When selling a rental property, the cost basis in India is calculated with indexed pricing, which often results in lower taxable gains compared to the US system, where the cost basis remains the original purchase price.
Because of this difference, it’s possible that the Indian government taxes you on a much smaller gain compared to what the US would tax you.
For instance, if you sold a property for US$500,000, India might tax you on a gain of US$50,000, whereas the US might consider the gain to be US$200,000 based on the original cost and depreciation recapture.
What are phantom gains and how do they impact US Green Card holders?
A phantom gain can happen if you have taken out a mortgage in Indian rupees to buy the property and the exchange rate changes significantly by the time you sell.
For example, if you borrowed US$100,000 worth of rupees when buying the property, and the value of the rupee drops, you might end up only needing US$80,000 to pay off the mortgage when you sell.
Even though you haven’t actually made a profit, the difference due to currency exchange rates can look like a gain on paper. The IRS considers this a mortgage settlement gain, and it must be reported when you file your taxes.
Unfortunately, while gains are taxable, mortgage losses due to currency fluctuations are not deductible, which can feel unfair but is part of the IRS rules.
How can US citizens minimize capital gains taxes on property sales?
To minimize your capital gains taxes when selling property in India, it’s important to take advantage of every available deduction and credit. This includes:
- Property Improvements: Deducting costs for improvements made to increase the property value.
- Selling Expenses: Deducting costs like realtor fees, legal fees, and marketing costs.
- Foreign Tax Credit (FTC): Claiming credit for taxes paid in India to avoid double taxation.
It’s also crucial to understand your eligibility for the US$250,000 exclusion or US$500,000 for married couples, as well as factoring in depreciation recapture if the property was rented. Working with a tax professional who understands both Indian and US tax laws can help you optimize your tax situation and avoid paying more than necessary.
