In this article, we are going to answer your questions about the IRS Capital Gains Tax & FIRPTA when selling assets in the United States
– Who pays Capital Gains Tax?
– When does Capital Gains Tax kick in?
– How is Capital Gains Tax calculated?
– How much Capital Gains Tax will I pay?
– How does Capital Gains Tax work?
– Can Capital Gains Tax be deferred?
– Where do I pay my Capital Gains Tax?
A step by step guide of how to sell an asset whilst minimising Capital Gains Tax
1 – Identify an asset to sell
2 – Work out the Capital Gains Tax in the US
3 – Ensure that FIRPTA does not get applied if not required
4 – Complete the tax return as part of your normal submission 15th April (when tax is due)
5 – File for a 1040 extension if you wish but note that the tax is still due 15th April
6 – Double check if there are any HMRC reporting requirements for foreign disposals and UK Capital Gains Tax
Who pays Capital Gains Tax?
As British expat tax experts, we know that you might have real estate or other assets in the United States and may look to sell those assets, which makes a taxable gain.
You, the property owner, would be held responsible for the calculation and payment of Capital Gains Tax.
When does Capital Gains Tax kick in?
Capital gains are made once you enter into a contract to sell the property in question. You do not need to pay Capital Gains Tax until
– You have received the money (if you are taxed at the 15% FIRPTA tax rate, more on this later)
– 15th April When you file your 1040 tax return to the US and pay your liabilities
– 15th October if you have requested a filing extension using the Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, which gives you six more months to prepare 1040 your tax return.
How is Capital Gains Tax calculated?
You pay Capital Gains Tax to the IRS on the gain that you have made.
$X Sales proceeds
$X Adjusted basis cost of the asset sold
$X Capital Gains Tax at the various tax rates (more on this later)
Capital Gains Tax Rates for individuals and married couples.
The IRS Capital Gains Tax rates are as follows:
0% – Taxable income is less than $78,750
15% – Taxable income is more than $78,750 but less than $434,550 (single) and $488,850 (married filing jointly)
20% – Where income exceeds those mentioned above
There are a few other exceptions where capital gains may be taxed at rates greater than 20%:
Capital Gains Tax rates at 28% in special circumstances.
The 28% special Capital Gains Tax rate applies when:
– Selling small business stock
– Selling collectables (such as coins or art)
The portion of any unrecaptured section 1250 gain from selling section 1250 real property is taxed at a maximum 25% rate, which is the depreciation tax rate that you would have benefitted from in the prior submitted 1040 tax returns.
What is the adjusted basis cost of an asset?
The IRS adjusted basis cost of an asset may be broken down as follows:
$X Original purchases cost of the asset
$X Capitalised items
$X Total cost brought forward
($X) Less: Casualty losses
($X) Less: Depreciation of the asset to be sold
A note on adjusted basis cost for real estate property
Real Estate Property: is land and generally anything built on or attached to it. Certain fees and other expenses become part of your cost basis in the property. Such items are:
– Abstract fees (abstract of title fees).
– Charges for installing utility services.
– Legal fees (including title search and preparation of the sales contract and deed).
– Transfer taxes.
– Owner’s title insurance.
– Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.
Real estate taxes: Real estate taxes is a cost if you paid it on behalf of the seller.
Capital Gains Tax example when selling a US asset
Here is an example where the person’s income is circa $80,000
$300,000 sales price
$200,000 Adjusted basis cost
$15,000 Capital Gains Tax ($100,000 X 15% Capital Gains Tax rate)
There is also an additional 25% depreciation recapture rate of 25%,
$50,000 depreciation amount
$12,500 recapture Capital Gains Tax rate ($50,000 amount depreciated X 25%)
In summary, we can now see the total Capital Gains Tax for selling a US real estate property would be:
$15,000 Capital Gains Tax
$12,500 Recaptured Capital Gains Tax due to depreciated amount
$27,500 is the total amount of Capital Gains Tax that would be due by the taxpayer
Foreign Investment in Real Property Tax (FIRPTA) withholding Tax
If you are a Brtish expat, it is possible that you not only pay Capital Gains Tax but FIRPTA too. Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. FIRPTA authorized the United States to tax foreign persons on dispositions of U.S. real property interests.
You must know the US tax law when it comes to selling US-based assets as a British Citizen. If you fail to understand it, then you may pay the 15% FIRPTA tax rate of the sale price rather than the Capital Gains Tax.
Paying FIRPTA could mean you are out of pocket. Let us take a look at an example.
$300,000 sales process of selling a real estate property investment
$45,000 FIRPTA at 15%
$255,000 cash after you have paid FIRPTA
The reason you might be out of pocket is that:
$400,000 original property value but you sell for £300,000 to get a quick sale
$300,000 mortgage on the original value
You now have to pay back the mortgage of $300,000 with the cash received of $270,000. This means you have to find the $45,000 out of your own pocket to pay the IRS and the mortgage company.
We have written a much more detailed article about Foreign Investment in Real Property Tax (FIRPTA) withholding Tax and how you may be able to take advantage of the FIRPTA exemptions so that you can avoid this nasty form of tax.
The difference between Capital Gains Tax and FIRPTA
From the above we can now see the amount of tax paid is:
$27,500 Capital Gains Tax including the 25% recapture rate
$37,500 excess tax paid due to FIRPTA
Please note that the excess $37,500 tax paid due to FIRPTA may be reclaimed upon the 1040 tax return submission to the IRS. That said you may be out of pocket for a period of time before you submit your tax return. Additionally, there could be a delay for the refund to be returned to you from the IRS.
Do you have an ITIN?
In order for you to submit a 1040 tax return to the IRS, you will need to obtain an Individual Tax Identification Number (ITIN). You can obtain an ITIN number by completing a W7 form, which with some ID may be taken to the IRS.
Within a few months, you will then be provided with an ITIN number. Couples need to be made aware that each person that needs to submit a tax return will require their very own ITIN.
Other useful articles that you may be interested in
Now that you have read this article be sure to read more about
A special note for those that need to submit a UK tax return to HMRC
Not only do you need to think about US tax payments to the IRS, but you also need to consider whether or not you have to pay tax in the UK too.
You may need to pay tax based on the Capital Gains that you have made to HMRC in the UK.
You can read more about Capital Gains Tax on Optimise Accountants website, whom that focus on helping real estate investors save tax in the UK.
The Capital Gains Tax rate in the UK is 18% for basic rate taxpayers (earnings up to £50,000 for 2019/20) and 28% for high rate taxpayers (earnings above the basic rate tax band). That said there is a Capital Gains Tax annual allowance available for people. It is therefore important to identify the ownership of the property to see if there is a UK tax advantage of owning the property between husband/wife or civil partners.
Optimise accountants have written an article about Capital Gains Tax when selling foreign assets. Be sure to read this article.