Selling a property in the UK
In the UK, individuals benefit from Principal Private Residence (PPR) relief. This allows individuals to sell their main home and pay no capital gains tax, assuming a few conditions on occupation are met.
Unfortunately, the Americans amongst us have another set of rules to play by. The Internal Revenue Service (IRS) has a worldwide reach on US citizens’ tax affairs, and the gain made on the sale of the family home, i.e. the main residence, is potentially subject to capital gains tax in the US.
How does this work?
US Tax and the $250,000 exclusion
At the moment, the first $250,000 of the gain (per individual) is exempt, but the excess is taxable. This can possibly change if the Biden administration decides to introduce tax changes in the future. While this may be a little way off yet, it could see capital gains being taxed at a new highest rate of 39.6%, for those with income above $1m.
Similar to the UK’s PPR rules, the IRS also has some specific requirements on who qualifies, based on occupation. Assuming all the rules are met, a couple could benefit from a $500,000 exemption in total.
Americans who have lived in the UK for an extended period of time can easily overlook this, as they may consider their financial affairs in British pounds, but the IRS does not.
Even though the property would have been purchased and sold in British pounds, the IRS would consider the equivalent dollar amounts for the purchase and the sale. Chances are this would have spanned several years, with large fluctuations in the exchange rate.
Phantom Mortgage Gain
Quite surprisingly, the potential pitfalls don’t stop there.
If a mortgage is held, you might assume that the debt is deducted from the asset value to reduce the potential gain. However, the mortgage is in fact considered a separate asset to the property.
Furthermore, paying off the mortgage can bring negative US tax consequence as the mortgage amounts on purchase and sale also need to be converted to dollars. If the debt being paid off on sale is lower than was originally taken out, this may be considered a ‘phantom mortgage gain’ which is taxable in the US.
Are there any other aspects I need to think about?
It is typical for a couple to own property jointly, however, where one spouse is a US citizen it may be advantageous from a tax point of view for the property to be owned solely by the non-US citizen spouse.
If the property is currently solely owned by the US citizen, there may be an option to transfer ownership. Be wary, there are limits on how much a US person can gift to their non-US spouse for gift tax purposes.
If there are sufficient assets to purchase a property outright, this may be advisable.
Of course, there is no ‘one size fits all’ approach to this type of planning, so it is vital to take advice and ensure your unique situation is considered with appropriate advice provided.
Another aspect to consider is whether a property falls into the value of an estate for inheritance tax (IHT) purposes.
In the UK, the amount that is exempt from IHT is considerably low, when compared to the more generous US estate tax exemptions, therefore planning is often required to ensure the best outcome for the next generation.
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