The Australian government doesn’t charge capital gains tax when you sell your house in Australia, as long as it has been your principal place of residence. What’s the problem with that? Well, if the ATO isn’t going to sting you on the profits of your home, guess who is? Yep, the IRS. As a tax resident of Australia, the ATO has first right to tax your income, and the IRS is second in queue. Because the ATO lets you off the hook, Uncle Sam will be right there with his pockets open.
If you’re a US citizen or Green Card holder who is interested in Australian property and capital gains, this blog post will be right up your alley. Jonathan Rose, our resident Tax Manager will delve into some of the challenges and will give a breakdown of how it works and what you need to know about capital gains tax.
How much will it cost me to sell my property in Australia?
As it turns out, the U.S. and Australia have different rules on how to treat primary residence sales. For Australians, selling their main home is not a taxable event so they don’t need to do anything about reporting that sale or paying taxes for it. However, Americans are required by law to report capital gains tax when there’s any sort of profit from real estate transactions.
U.S. citizens and Green Card holders who sell their primary residence in Australia may end up paying capital gains tax. This is due to the fact that if they haven’t lived and owned the property for at least two of the previous five years, it will be considered a taxable transaction under U.S. law. Those filing joint returns are exempt from taxation up to $500,000 (assuming the property is co-owned) while single-filers are only exempt on the first $250,000 profit.
What kinds of expenses can be deducted from the profits before paying capital gains taxes on my renovated property?
We’re looking at two types of expenses: selling expenses, which are certainly deductible, such as real estate commissions paid to your real estate agent or broker, legal expenses, and one-time payments related to the sale, which are also deductible. For the cost basis, (which is how much the property cost you), we don’t just look at what you originally paid, but the value and cost of improvements you make to the property along the way.
Unfortunately, when you do renovations to your own place in Australia, don’t include labor costs because these are excluded from calculations. However, all materials used can be included in building cost estimate. After buying your property, all your selling costs plus renovations can be added together (except your own labor) and now you have your true cost. That’s the amount we deduct from the sale price to see the real profit. If half of the house is yours, simply divide the amount by two, and that’s your share. If that amount is more than $250,000 then you’re likely going to have to pay U.S. Capital Gains Tax on every dollar of profit above the $250,000.
Would I be able to deduct $250,000 from my profit if my spouse is an Australian?
Assuming you own the property together, your sale proceeds such as real estate commission and conveyancing solicitor fees will be subtracted from your profit to arrive at the taxable amount. These gains are then split in half, and this amount is your part of the profit; essentially 50% of any gain.
How much is the IRS going to tax me above the $250,000 exemption?
Selling a share is treated the same as selling any other capital property. If you hold that asset for more than a year, it will be taxed at your long-term capital gains rate of 15%; if you’re in the top tax brackets and sell a property, it’ll be 20%. The capital appreciation on Australian properties has been massive and if you buy a property 20 to 25 years ago in Australia, you will likely get a huge gain that could easily put you on the 20% type bracket especially when added on to your other income.
Can I earn a $500,000 capital gains tax free if I included my Australian spouse on my U.S. tax return?
You can tell you’ve got your thinking cap on. If you are a US citizen who owns 100% of the property, it may make sense to voluntarily bring your Aussie spouse into the U.S. tax system so you may benefit from the $500,000 exclusion. There are a few things to consider, and they are not without risk. To begin, you must make certain elections to add your spouse, and they must obtain a taxpayer identification number (ITIN). The IRS may be unpleasant if your Australian spouse also has a lot of assets. All the Australian tax planning is also subject to the U.S. tax system. Keep in mind, you’re being taxed on your half of the profit, and they will then be taxed on their half of the profit, so there may not be any benefit if your profit is over $500,000.
It can really help when the property is actually yours and you’ve made a profit between $250,000 and $500,000. Imagine you’re going to file on your own and you’ve made $400,000 profit. We can take the first $250,000 away and you’ll pay capital gains tax on the remaining $150,000. At 20%, that means you’re handing over $30,000. If you bring your spouse into the picture and the house belongs half to them, there is nothing to pay at all, because the first $500,000 is exempt. There are serious considerations, so get professional advice before you do this.
Is it that simple? Can I add my Australian spouse to my U.S. tax return, even though it has nothing to do with the U.S.?
It’s not simple. When you make elections, some of them are binding while others only apply in certain years. You should seek professional advice before making these decisions because there could be unintended consequences to a non-residents spouse filing with the taxpayer identification number on their return if they didn’t have one previously. It can be done, but it needs to be done carefully by a professional.
I want to know more about US Taxes abroad
Do I have to pay U.S. tax if I have rental income from Australia?
Whether you’re living in the United States or Australia, your income will definitely show up on tax returns and be reported to both governments accordingly. If your property is positively geared (i.e., making money from rent), then this positive cash flow can offset any taxes paid to the ATO, so there’s no double taxation at the U.S. federal level either way. So, in practical terms, you will not have to pay tax on your rental property.
How does it show up on a U.S. tax return if I have a rental property in Australia and sell it? Is it the same in terms of capital gains on the U.S. side?
A rental property is considered a business asset, and its sale will be completely taxable. In Australia it’s the same; any tax paid in Australia on your rental property can be used as foreign credit for U.S. taxes. When selling the property, you will calculate your cost price using an exchange rate on that day. You’ll also need to include any long-term improvements made on the property; these are part of its value as well.
If you have claimed rental expenses on your U.S. tax return, the cost basis accumulates over time. You can’t recoup deductions twice; if you want to sell it and claim a new deduction, recalculate how much of this income is taxable. The amount taxed will be taken into account but no exemptions or deductions are necessary for capital gains taxes (US). There’s almost definitely going to be some sort of taxation owed in Australia as well since there has already been money earned from the property sale.
If you have to pay ATO taxes on your rental property, we can use those tax dollars to offset some of the U.S. tax. At the very least, there are no differences between tax statements: the date and taxation are the same, so we can always use foreign credits. It distinguishes itself when selling primary residences because their systems are vastly different.
If I married an Australian, would it be better to put a rental property entirely in their name?
If you’re married to someone who is outside the U.S. tax system, it’s a good idea to put all of your non-U.S. assets in their name (if you trust them). It simply means that you will not have to deal with any U.S. tax issues. It’s important to get personalized advice, but if you don’t have it on your name as a U.S. citizen, you don’t have to worry about the IRS coming after you.
Do I have the option to put my non-American spouse in the mix if all of the tax I paid to the ATO would be credited on my U.S. tax return?
You may have the option, but what’s the reason? If your U.S. tax is all offset by tax paid to the ATO, there may not be any benefit to adding your spouse to your U.S. tax return.
What about expenses, receipts and tracking costs?
Keeping good records is the only thing to suggest throughout your ownership period. So, keep hold of every expense you have and make a record for each time you got in or made an improvement to something. You just want to make sure that when it comes time to file your tax return, you have a good record of every cent you’ve spent because everything you claim as an expense can save you tax, which means more money in your pocket.
A basic spreadsheet and a shoebox for receipts will do the trick.
Can I simply put a lot of money in my superannuation account?
Putting a large sum of money into your superannuation account can have negative consequences, as the IRS is not forthcoming with their guidance on it. They are ok with people who have regular superannuation plans in which your employer contributes a small sum of money each time you are paid. When you put your own money into your super fund, the IRS becomes very interested, which can cause a lot of problems on the U.S. side. As soon as you’ve contributed more money into your super fund compared to your employer(s) the game changes, drastically. It’s definitely an area where you need to tread carefully. Get in touch so we can help. Sometimes, putting the brakes on can save you a lot of money, we can look at your superannuation balance and various contributions throughout the year you’ve worked, and we can put on an amount that we can go in without triggering any U.S. consequences. We can check our account to see what the maximum is without causing harm to ourselves.
When you retire and take a portion of your superannuation money and do I have to pay U.S. tax on it?
Unfortunately, U.S. citizens are subject to taxation on their superannuation plans. This means that if money starts coming out of your superannuation plan, it is taxable income (unless you’ve already disclosed it in the year you earned it). Taxable income falls under a certain line called “pension” in the tax code and therefore will be taxed based on where this line sits within different tax brackets for taxpayers. There is one big exception and something we try to do for all clients in Australia… we bring your Superannuation onto your US tax return every year you earn it… so it’s already been subject to US taxation. This means, when you take it out, there is nothing to tell the IRS. Too many people think that not telling the IRS about their Super is unnecessary or even worse, a smart thing to do!
What if I’m an American or green card holder living in Australia and earning superannuation, what’s the best way for me to mitigate the damage before I reach the retirement age?
When you file your U.S. tax return each year, it comes with proper compliance. The amount your employer contributes to your superannuation account is another source of income for you, and it can be locked away and unavailable to you, but from a U.S. perspective, it’s just another wage component. By including that as a wage income on your U.S. tax return, we’re creating a cost basis in superannuation funds that will eventually be used 10 to 20 years down the line when you take some money out.
If you already pay so much tax in Australia on your wages, we have this full foreign tax credit that allows us to draw from our funds without paying any additional taxes. For instance, if you make $5,000 per month plus $1,000 in superannuation, you don’t report the $5,000 to the IRS; instead, you report the $6,000 per month because you paid so much more tax in Australia than in the U.S., and you obtained enough foreign tax credit to virtually offset the entire $6,000. You may have a share of growth, such as the amount that will be included between today and 20 years from now.
The IRS won’t charge you taxes on the interest that accumulates in your superannuation fund if it’s been put away for 20 years. This is because when tax brackets and income rates change, they don’t add a flat rate of taxation to other incomes, so these changes aren’t covered by foreign exclusion laws.
Is there anything that can be done to alleviate the pain when the IRS gives you a tax-free threshold and you have to pay tax on anything above that?
Since the income is recorded to a U.S. tax return, any deductions that you’re entitled will still apply and be treated as if it were normal income (e.g., standard deduction or itemized deductions). There’s nothing special about this; though if you do not have other forms of taxable income and want to stick with your U.S. tax returns, we recommend seeking professional advice from tax accountant so that when filing each year, all advances can be maximized for maximum savings on taxes.
Contact us at Expat US Tax to have an initial free 20-minute consultation regarding with the tax implications of selling your property in Australia and managing and planning your Superannuation in relation to U.S. tax.