Understanding Capital Gains Taxes: What Expats Need to Know

Capital gains are profits earned from selling assets, such as property, bonds, jewelry, or stocks, higher than their original purchasing price. All capital gains a US expat makes are taxable by the IRS and must be reported on your US expat return. However, the tax rate will vary depending on how long the asset has been held before selling it.

In this article, we’ll cover what expats need to understand about capital gain taxes, the distinction between short- and long-term capital gains, how to report capital gains on your US expat tax return, and strategies to minimize tax liability. With years of expertise, MyExpatTaxes’ Tax Professionals are specialists in capital gains taxes!

Sources of Capital Gains

Some of the most common sources of capital gains for expats are from the sale of:

• Property
  • If you sell your home abroad for $250,000 or less, the capital gains or net profit will not be taxed if it was your primary residence. This tax-free amount increases to $500,000 for those filing under married filing jointly.
• Stocks, mutual funds, ETFs
• Bonds
• Cryptocurrency
• Business ownership or interests
• Cars or boats

Short- vs Long-Term Capital Gains

Short-term capital gains (where the asset has been owned for 12 months or less) are taxed as regular income, taxed as ordinary income tax rates. The rate can be as high as 37%; however, your tax bracket will determine the exact percentage.

Short-Term Capital Gains Tax Rates for Tax Year 2024

Depending on income thresholds, long-term capital gains can be taxed between 0-20%. The average rate for taxpayers is 15 or less percent.

Long-Term Capital Gains Tax Rates for Tax Year 2024

Business Capital Gains

An additional layer of complexity arises when you sell business assets. Many taxpayers are surprised to learn that a home, if ever rented out, is considered a business asset because it is used to generate income.

Business capital gains, such as those from the sale of depreciable business property or real estate used in a trade or business, are generally reported on Form 4797 (Sales of Business Property) instead of Form 8949. Unlike personal capital gains, which typically fall under short-term or long-term capital gains tax rates, gains reported on Form 4797 may be subject to different tax treatment.

For example, Section 1231 gains can receive long-term capital gains treatment if they result in a net gain; Section 1245 and 1250 recapture rules may cause a portion of the gain to be taxed as ordinary income rather than capital gains.

• Section 1231 Property includes depreciable business property and real estate used in a trade or business for over a year.
• Gains are taxed at long-term capital gains rates if the net result is a gain.
• Losses are treated as ordinary losses, allowing full deduction against ordinary income.
• Section 1245 Property (Depreciable Personal Property)
  • Covers depreciable personal property (e.g., machinery, equipment, vehicles).
  • Depreciation recapture applies: any gain up to prior depreciation is taxed as ordinary income.
  • Only gains beyond depreciation recapture qualify for capital gains treatment.
• Section 1250 Property (Depreciable Real Property)
  • Includes depreciable real estate (e.g., buildings, rental properties).
  • Recaptures excess depreciation over straight-line depreciation as ordinary income.
  • The remaining gain may be subject to capital gains tax, with unrecaptured Section 1250 gain taxed at a maximum of 25%.

This distinction is crucial because it can significantly impact taxpayers’ tax liability.

How Capital Gains Are Reported on Your US Expat Tax Return

The capital gains will be reported as income and taxable if you profit. The calculation is simple:

The selling price – (original purchase price + improvement costs + selling fees) = capital gains.

Remember to:

• Comply with FATCA and FBAR requirements
• Report capital gains on Form 1040 Schedule D and Form 8949
• Determine if the capital gains were short- or long-term
• Apply currency exchange rates, as you will be required to report in USD
• Correctly report capital gain taxes in the country of residence as necessary

Common Exemptions and Deductions for Expats

• Foreign Tax Credit: If you are selling property abroad, you can utilize the FTC to reduce your US taxable income dollar-for-dollar. That means you would only need to pay capital gains in your country of residence, not in the US if you have paid enough locally.
• Foreign Earned Income Exclusion: The FEIE does not apply to capital gains; it only covers earned income, such as wages or salaries.

Strategies for Minimizing Capital Gain Taxes as an Expat

• Timing of Sale: An effective strategy to minimize capital gains taxes is to hold investments or assets for the long term. The US taxes capital gains at a lower rate (longer than one year) than short-term gains. By timing the sale of your asset, you can reduce your overall tax liability.
• Utilizing Tax-Advantaged Accounts: Certain retirement or investment accounts can offer tax benefits depending on your country of residence. If you are in a country with tax-deferred or tax-exempt accounts similar to US IRAs or 401(k)s, it may be possible to use these to your advantage to either defer or exclude taxes on capital gains. It will always depend on local laws and the specifics of the account. Remember that local tax benefits and deferrals rules may not be applicable on the US side.
• Tax Planning: By consulting the tax professionals at MyExpatTaxes through MyExpatPlanning, US expats can effectively plan to minimize their capital gains taxes. Whether it’s taking advantage of available tax treaties, tax credits, deductions, or strategically timing asset sales, our experts are here to assist every step of the way!

Common Mistakes to Avoid

• Failure to Report Capital Gains (Underreporting): Many expats overlook or even forget to report capital gains on their US tax returns. Failure to report capital gains taxes can lead to penalties with interest.
• Misusing Tax Treaties: Tax treaties are notoriously confusing, causing expats to overlook the details between the US and their country of residence. While most tax treaties have a section on how capital gains should be reported and which country has tax rights, these benefits are typically not exempt from the savings clause, meaning US citizens cannot use them.
• Forgetting the Currency Exchange Impact: Currency fluctuates and can quickly affect capital gains’ value when converting foreign currencies to USD. Remember to consider the impact of exchange rates on your reported gains to ensure accurate reporting.

Understanding and managing capital gain taxes as a US expat will help you stay compliant and minimize your tax liability. Dealing with the complexities of tax treaties, the timing of asset sales, or currency exchange implications can be a challenge!

That’s where MyExpatTaxes comes in. Our experienced Tax Professionals are here to guide you through every step of the process with MyExpatPlanning and offer personalized advice tailored to your situation.

Get started for free, pick a plan when you’re ready. Or see the Pricing Page for all the details.