Depreciating Foreign Rental Property and IRS Rental Income Tax Rules

Foreign Rental Property Depreciation 

Foreign Rental Property Depreciation & IRS Income Rules: The United States is one of the few countries that taxes U.S. Persons on their worldwide income. Therefore, when a U.S. Person has foreign rental income from a property outside of the United States, that income is taxable and reportable on a US tax return. Specifically, foreign rental income and depreciation are included on IRS Form 1040 Schedule E. Depreciation is a new concept to many U.S. taxpayers, since many foreign countries do not allow for depreciation – or if they do it is not very beneficial from a tax perspective. Conversely, in the United States depreciation can significantly reduce a person’s income tax liability. Let’s go through some of the basics about foreign rental property depreciation and how foreign rental income is calculated.

What is Foreign Rental Property Depreciation?

Depreciation is the concept of being able to deduct the loss in value structure as time goes on. With real estate, it is generally broken down into two different portions – the land and the structure. Land will generally increase in value, and it is not depreciable. Conversely, a structure will normally reduce in value, either because it has gotten old or outdated. As a result, a person has the ability to depreciate the value of the structure or improvements over a certain amount of time — depending on whether it is a residential or commercial structure and whether the structure is located in the United States or abroad.

Depreciation of Foreign Residential Rental Property

When it comes to depreciating foreign residential property, it is now generally done over 30 years instead of 40 years which is how it was done before 2018. 

Here’s a common example of how it works:

• • • Amy has a rental property in Australia. 

    • The value of the property is $600,000, and the structure is valued at $300,000.

    • Amy may depreciate the $300,000 value of the structure of over 30 years, which results in a $10,000 annual depreciation.

    • If Amy generates $25,000 dollars a year in rental income, with $15,000 worth of deductible Schedule E expenses for the property, she would result in  $10,000 of income — which would be taxable.

      • Now, when Amy factors in the $10,000-dollar annual depreciation, the tax liability becomes zero, because there is zero net income.

It is important to keep in mind that when Amy goes and sells the property at a future date, the adjusted basis will change in order to reflect the depreciation. But, since Amy is only in the United States temporarily and is on a visa with no intention of becoming a citizen or resident – this may not be a problem.

Foreign Commercial Rental Property Depreciation

Foreign Commercial property works the same way except it is over 40 years instead of 30 years.

*U.S. residential property is depreciated over 27.5 years and commercial property is depreciated over 39 years.

How is Foreign Rental Income Taxed

With foreign rental income, the income is reported on Schedule E.   A very important concept to remember is that the reporting is not limited to profit. In other words, even if the person nets out a loss as a result of the expenses or deductions exceeding the gross income – the income and expenses are still reportable on Schedule E. In other words, the individual will include the income along with all of the expenses and depreciation. And, depending on whether the individual qualifies for actively participating in a passive activity loss – the loss may further reduce overall tax liability.

Golding & Golding: International Tax Lawyers

Our firm specializes exclusively in international tax, and specifically IRS offshore disclosure.  Foreign pension tax and reporting is a common issue we handle.

Contact our firm for assistance with getting compliant.