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Discussion Starter · #1 · (Edited)
Hi,

I am a Canadian expat living and working in the US. We have a few rental properties in Canada and I would like to understand how FX fluctuations will impact our US taxes. We have declared the income on all of our rental properties on our US taxes, and have established cost basis and also depreciated the properties as required.

Below is a an example to help answer my below questions:

* Purchased rental property in mid-2012 for $300,000 CAD

* The exchange rate at the time was almost par, so our USD cost basis on this property is $300,000 USD.

* A mortgage of $250,000 CAD was registered against this property at purchase

* If I were to sell the property for $300,000 CAD today the USD cost basis for the sale would be $240,000 USD assuming a 1 USD = 1.25 CAD exchange rate

* The mortgage balance that would need to be paid off upon sale would be $230,000 CAD

* Property has been a rental property from day one. ( Does this have any bearing on the situation? Since we were living in one of the properties prior to the move but has since been rented).

Questions:

* Would I actually be registering a loss of $60,000 USD on my US taxes?
* If so will this be treated as a capital loss or an ordinary loss that can be deducted against earned income?
* If not how is this FX fluctuation going to impact my taxes?

In reality I will not have any capital gains or losses from a CAD perspective since I will be selling it for the same purchase price. However I will owe tax on depreciation recapture to Canada, but this is minor. I am unsure how this will be treated by the IRS however.

If indeed the FX fluctuation will work in my favor I should be motivated to sell the property at the current exchange rates because the $60,000 USD if deductible from ordinary income would be worth more than $20,000 USD to me.

Any advise regarding this matter would be much appreciated.

Thanks
 

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* Property has been a rental property from day one. ( Does this have any bearing on the situation? Since we were living in one of the properties prior to the move but has since been rented).
It could if there were a gain and if your residence were sufficiently long within the past 5 years.

* Would I actually be registering a loss of $60,000 USD on my US taxes?
If you're asking whether exchange rate fluctuations alone can result in a loss on the U.S. tax side, yes they can.

* If so will this be treated as a capital loss or an ordinary loss that can be deducted against earned income?
Usually a capital loss. Ordinary losses are sometimes possible when there's a trade or business involved.

If indeed the FX fluctuation will work in my favor I should be motivated to sell the property at the current exchange rates because the $60,000 USD if deductible from ordinary income would be worth more than $20,000 USD to me.
Congress and the IRS thought of that, which is why capital losses are (generally) limited. However, you can combine sales. For example, if you have another property that has gained ~$60,000 (in U.S. dollar terms) you can sell that, too, and your capital loss will offset your capital gain.

But yes, foreign currency fluctuations can work in your tax favor. "Eyes on the prize," though. It's not generally a good thing to lose money (in any currency), so that wouldn't be the investment objective I would recommend.
 

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Discussion Starter · #3 · (Edited)
I actually wouldn't be losing any money because I would have invested $50,000 CAD as a down payment on the property, and would be walking away with $70,000 CAD once I paid off my mortgage.

So I invested $50,000 USD based on exchange rates in mid-2012 and walk away with $56,000 USD based on 2015 exchange rates. So I actually made $6,000 USD.

What are the limitations on capital losses and how long can I actually carry them forward?Unfortunately I don't have any capital gains that I can offset with these losses. I was under the impression this would be considered a Section 1231 loss, therefore allowing me to reduce earned income. Would this not qualify?

The reverse of this situation would have been a catastrophe so one really needs to be careful with tax implications of foreign rental properties.

Thanks
 

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What are the limitations on capital losses and how long can I actually carry them forward?
The annual limit is $3,000 ($1,500 if Married Filling Separately). There is no intrinsic time limit to carryovers.

I was under the impression this would be considered a Section 1231 loss, therefore allowing me to reduce earned income. Would this not qualify?
I mentioned "trade or business" in my reply above. Yes, Section 1231 losses are one form of losses associated with a trade or business. You'll have to check those rules to see if the property qualifies. If the property qualifies, great.

The reverse of this situation would have been a catastrophe so one really needs to be careful with tax implications of foreign rental properties.
Only if you consider an increase in U.S. dollar denominated wealth to be a catastrophe. That seems to be a bit strong. Also, a Section 1031 exchange is potentially available -- and that can be quite powerful when dealing with various foreign currencies since you're allowed to exchange a rental property in Canada for one in, say, Ecuador. The countries don't have to be the same, as long as they're both foreign.

One thing that might be missing in your gain/loss calculation -- I can't quite tell -- is adjustment for the depreciation you took. Quoting Intuit: "The tax basis is generally your original purchase price, plus the cost of improvements (not counting expenses you’ve deducted as repairs and maintenance), minus any depreciation deductions you claimed while you owned it." On a 40 year depreciation schedule that's not much, but it's part of the calculation.

Don't forget FinCEN Form 114 and/or IRS Form 8938 to report the overseas financial accounts associated with the proceeds from the sale.
 

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One factor you appear to be overlooking here is depreciation. Normally, for rental property, you must deduct from your basis
Depreciation you deducted, or could have deducted, on your tax returns under the method of depreciation you chose. If you did not deduct enough or deducted too much in any year, see Depreciation under Decreases to Basis in Publication 551
this from IRS Publication 527

So, your actual basis for the property is what you paid for it (converted to US$ at the date of purchase) less depreciation (which should be converted to US$ at the rates for the years you owned the property and took, or could have taken depreciation). And actually, what you received on the sale of the property is converted at the rates for the date of the sale.

If you lived in part of the property for a time, that portion has to be excluded for depreciation purposes, then added back when you vacated and reconverted it to rental property.

It sounds a little complicated, but actually makes logical sense.
Cheers,
Bev
 

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Discussion Starter · #6 ·
Thanks for the responses.

Sorry I should have mentioned depreciation as well. The property is being depreciated and I was able to write off some of my income due to depreciation but this was relatively small. Most of the depreciation will be in the form of PAL and will need to be realized the day of sale.

So for arguments sake the cost basis for the property has been reduced to $285K USD after depreciation

* 5k USD of this was written off against my income

* 10k was PAL which I was not able to write off because I did not have passive income to write it off against.

My main question is do these properties qualify under Section 1231? Based on what I have read they seem to qualify but I am not sure if there are any restrictions for foreign properties qualifying under Section 1231?

Under the above depreciation circumstances I believe the $10K PAL losses will be realized the day of sale as an ordinary loss and can be deducted against ordinary income.
 

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I may be drawing a blank here due to our mini-heat wave, but I'm not familiar with the term PAL. It is very common under US tax law for rental properties to generate paper losses, thanks to the depreciation. It's that depreciation that must be deducted from the original basis of the property (no matter how the purchase was financed) that may turn your sale into a somewhat substantial gain, even if you sell for less than you paid for the property.
Cheers,
Bev
 

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Discussion Starter · #8 ·
Hi Bev,

PAL is the Passive Activity Losses - since I am forced to take depreciation I will be having a loss for the forseeable future, however since you cannot right off this passive loss against income it accumulates and I believe can be taken against the gains when you sell the property.

My main question do these properties qualify under section 1231 ?
 
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