Almost from the moment President Trump signed his Tax Cuts and Jobs Act into law on Dec. 22, 2017, the expatriate American-focused tax advisory industry has focused on its implications for those Americans with an ownership interest in an overseas company, and their consequent new tax obligations.
But that wasn’t the only aspect of the Tax Cuts and Jobs Act that has significant implications for Americans who live outside the U.S., Dubai-based tax expert Virginia La Torre Jeker, pictured above, says. Here, she addresses in detail how the TCJA impacts Americans overseas who own their own homes.
Although it was more than a year ago that President Trump signed his sweeping tax reform legislation into law, it is only now, as tax returns are being prepared for the 2018 year, that many individuals are coming to grips with the impact Trump’s Tax Cuts and Job Act (TCJA) is going to have on their finances.
As a result, I’ve had numerous calls recently concerning two questions in particular that Americans who live overseas, and who own a foreign residence, are having. The first of these questions has to do with whether U.S. persons who live abroad, and who have mortgage loans secured by their foreign residence, can still deduct the mortgage interest they pay.
Their second question is whether they can deduct any foreign real property taxes they pay.
Briefly, the answer to the first question is yes, mortgage interest is still deductible under the new rules, but the deduction is more strictly curtailed.
As for the second question, sadly, under the TCJA, foreign property taxes are no longer deductible at all.
That said, if you are an employee living overseas and your employer provides you with a housing allowance for your living expenses, through a housing allowance, all may not be lost. More on that in a moment, as I work through the tax rules with you, and, as one does, come up with a sound workaround (which is what your tax adviser, if you have one, should be doing, btw).
In the meantime, here’s everything you need to know.
1. Mortgage interest deductions
Under pre-TCJA rules, a taxpayer could take an itemized deduction for so-called “qualified residence interest.” Generally, this is interest paid on a mortgage secured by what the tax law calls a “qualified residence.”
A “qualified residence” is a principal residence (e.g., the taxpayer’s primary home) and one other residence owned and used by the taxpayer as a residence (think, vacation home). These rules remain the same under the new law, and it does not matter whether the residence is located in the United States or overseas.
versus “home equity indebtedness”
Prior to the TCJA, American taxpayers could deduct two types of interest from their taxes: interest related to “acquisition indebtedness” and interest related to “home equity indebtedness.” As mentioned, in order to qualify, the loans had to be secured by the "qualified residence."
“Acquisition indebtedness” was the term for basically any type of loan that was used to purchase, build, or “substantially improve” any “qualified residence” of the taxpayer.
Interest on loans up to US$1m (or US$500,000, in the case of a married individual filing a separate return) was eligible for this deduction.
“Home equity indebtedness,” which taxpayers could deduct the lesser amount on interest paid on loans of up to US$100,000 from their taxes for “any indebtedness [loan] that does not already count as acquisition indebtedness, so long as it’s secured by a “qualified residence”.
While the home equity indebtedness debt still had to be secured by a "qualified residence", taxpayers enjoyed discretion as to how the funds from the loan were used. They could use the borrowed funds to finance a new car, pay tuition fees, or pay off their credit card debts.
It didn’t matter what the borrowed money was used for; because it was secured by the taxpayer’s “qualified residence,” the interest on loans up to US$100,000 was still deductible.
How the TCJA changes the
mortgage interest deductibility rules
The TCJA rules have changed all this – but only temporarily. And there are some exceptions to the new regime.
For starters, for the eight tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for interest on “home equity indebtedness” has been completely suspended – in other words, deductions of the kind described above will no longer be permitted.
Deduction for mortgage interest on “acquisition indebtedness,” meanwhile, will still be permitted, but it’s now limited to underlying indebtedness of up to US$750,000 (or US$375,000 for married taxpayers filing separately).
Going forward, unless these changes introduced by the TCJA are extended by Congress, they will “sunset” (i.e., expire) on January 1, 2026, and the more generous, pre-TCJA mortgage interest deduction regime will be reinstated.
to the new regime
That said, as noted above, there are a few situations under which the TCJA has “grandfathered” certain mortgage loans for “acquisition indebtedness,” and allows them to take advantage of the more generous, pre-TCJA deductibility benefits.
• “Acquisition indebtedness” that was incurred prior to December 15, 2017. In other words, taxpayers who took out a loan that was used to purchase, build, or “substantially improve” their “qualified residence” may still deduct the interest they paid on loans valued at up to US$1m (or US$500,000, if filing separately from their spouse).
There is no similar exception from the new regime for “home equity indebtedness”, however, even if it was incurred prior to December 15, 2017.
• The “binding contract” exception. This applies to a taxpayer who had entered into a binding written contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018.
If they in fact went ahead and purchased such residence before April 1, 2018, they shall be considered to have incurred their “acquisition indebtedness” prior to December 15, 2017. And therefore, under this exception, such a taxpayer would be allowed to take advantage of the pre-TCJA US$1m limit.
• The refinancing exception. Taxpayers who refinanced any existing qualified residence indebtedness that was incurred before December 15, 2017 may continue to avail themselves of the more generous, pre-TCJA’s US$1m/US$500,000 limits, so long as the indebtedness resulting from the refinancing doesn’t exceed the amount of the refinanced indebtedness.
(To read the IRS’s take on this, in the form of guidance entitled “Interest on Home Equity Loans Often Still Deductible Under New Law,” click here.)
2. Permissible deductions for
payment of foreign property taxes
The other big question many Americans who live abroad are asking right now, as I noted above, has to do with the deduction for foreign property taxes these Americans may have paid, in their current country of residence.
As mentioned, the TCJA has completely done away with this deduction.
Let's compare this scenario to when property taxes are paid to a U.S. state, with respect to a property within that state.
In this case, these state property taxes remain deductible on the taxpayer’s federal income tax return (subject to dollar limitations).
And yet, under the TCJA, an American citizen who lives abroad and owns a home there, and pays property taxes on it to the government of the country in which he resides, can not deduct the amount he’s paid on his U.S. income tax return at all.
Surprisingly, this particular TCJA provision has not received much press, but I think it could down the line, as it may be seen to unfairly increase the taxable income of the many U.S. taxpayers who happen to own their homes in the foreign country in which they live.
At issue is the fact that whether someone is living at home in the U.S. or abroad, the property taxes they pay are seen as a legitimate payment for the various services they receive from their local government, such as rubbish collection, maintenance of streets and other infrastructure, water pipes, electricity and so on.
Americans who live abroad don’t receive these services from the U.S., because they’re not there to receive them.
By not permitting them to deduct this amount from their U.S. taxes, it could be argued that these expat taxpayers are effectively “paying” twice for the services they’re receiving: once in the country where they live (and where they actually are receiving the services provided by the local government); and once to the U.S. government, in the form of an amount they cannot deduct from their taxes, even though their state-side counterparts can take such deductions for any local property taxes they pay.
This is, of course, but one of many examples of how the U.S. tax laws discriminate against U.S. persons living abroad. To read about other examples, see some of my previous postings.
exclusion may help
There may, though, be more than one way to skin this particular cat.
What follows is a fairly complicated discussion, which I shall endeavor to simplify as best I can.
Let’s say that you’re an employee living overseas, and receive a housing allowance from your employer for your non-U.S. housing costs. If this is the case, you may not be as badly affected by the TCJA’s changes as those who don’t enjoy such a benefit.
Americans abroad who own their own homes overseas (as opposed to renting them) are typically paying both mortgage interest and foreign real property taxes. In such situations, it may be possible for them to use the Section 911 foreign housing exclusion (FHE) provisions, with regard to the excess mortgage interest and the foreign property taxes that are not deductible under TCJA.
Typically, the American abroad who uses the FHE is renting his residence, rather than owning it. Typically, the owner will be the party paying the interest and property taxes.
The FHE is available for certain amounts of overseas "housing expenses" paid or reimbursed by an employer; the employee need not pay tax on these amounts paid by his employer, due to the FHE rules.
Allowable housing expenses are the reasonable expenses paid for foreign housing.
The relevant U.S. Treasury regulations provide a list of such expenses, but the list is not all-inclusive.
See Treas. Regs. Sec. 1.911-4(b)(1).
Examples of reasonable housing expenses include such items as rent, utilities (not including telephone charges), and real and personal property insurance. The expenses must actually be paid or incurred during the year by the taxpayer, and reimbursed by the employer, or paid by the employer on the taxpayer’s behalf.
Certain items will not qualify, such as capital expenditures, the cost of purchased furniture, domestic labor and other items.
Section 911 also does not permit an exclusion for, among other things, interest or taxes of the kind deductible under Code Sections 163 (interest) or 164 (real property taxes).
(To read more on the subject of Section 911, see my discussion on my blog, here.)
Can mortgage interest, property taxes
be the new ‘qualified housing expenses’?
Before the Tax Cuts and Jobs Act of 2017 was passed, the only reason for not allowing mortgage interest deductions and foreign real property taxes as a qualified foreign housing expense was because they were deductible elsewhere, under Sections 163 and 164, respectively.
(Looked at in another way, if the taxpayer could take a deduction and simultaneously exclude the amount under Section 911, a "double benefit" would result. Understandably, the tax law seeks to prevent this.)
Now, though, as we’ve observed, mortgage interest deductions have been reduced under the TCJA, and the deduction for foreign real property taxes is no longer permitted.
Since the excess mortgage interest and foreign real property taxes can no longer be deducted under Sections 163 and 164, the rationale for flat-out denying Section 911 treatment arguably falls away.
In a nutshell, it may be possible that foreign real property taxes and excess mortgage interest that is related directly to the foreign housing itself (e.g., compare "acquisition indebtedness" with "home equity" indebtedness), could be treated as a "qualified housing expense" for purposes of the Section 911 foreign housing exclusion.
This premise relies on the fact that they are no longer allowable as deductions under the tax rules, but they remain a reasonable expense directly attributable to foreign housing.
With this general concept in mind, let's take a simplified example involving foreign real property taxes and see how it might work. Assume that someone is an American citizen and taxpayer, living and working abroad, who owns his or her own home overseas, and pays foreign real property taxes on it.
Assume the individual’s employer provides a lump sum housing amount of say, US$40,000, and the individual owns their own home in the foreign country in which they live, and pays foreign real property taxes of US$10,000. It seems to me that this individual might potentially use Section 911 to exclude the US$10,000, on the grounds that these property taxes are reasonable expenses paid for foreign housing.
(They would have to include in their income statement the balance of US$30,000 provided by their employer, since they did not use this amount on overseas housing expenses, such as rent.)
This, it seems to me, seems a valid approach. But I should stress here, as I always do, that this article is for general informational purposes only, and is not intended as specific legal or tax advice.
For this you should seek a formal consultation with me or consult your own professional adviser to obtain advice relevant to your specific situation.
Virginia La Torre Jeker is, as reported above, a long-time U.S. expat tax law practitioner, who has been a member of the New York State Bar since 1984. Now based in Dubai, she is also a prolific blogger, currently at us-tax.org, and previously at AngloInfo.com.
- Monte Silver counters IRS ‘dismiss’ motion in U.S. Court
- IRS responds to Transition Tax lawsuit with 'Motion to Dismiss'
- Monte Silver: TCJA still a major problem, but some progress seen in recent GILTI revisions
- GILTI tax webinar on Thursday to feature tax lawyer Silver
- Proposed IRS tweaks to GILTI regs seen giving break to American taxpayers resident in high-tax countries