Selling Your Foreign Property - US and UK Tax Implications
U.S. expats living in the United Kingdom should always be cognizant of the fact that their activities could have tax implications in the both the United States and the United Kingdom.
Case in point – U.S. expats selling their residence in the UK should be aware of the tax considerations in both countries.
In this blog, we review the exemption from the capital gains tax on the sale of a personal residence, which may be available both for U.S. and UK tax purposes. Each country has its own set of conditions that must be met in order to qualify for the respective exemption.
Selling Your Foreign Property – the US Tax Exemption
On the U.S. tax side, section 121 of the U.S. Internal Revenue Code allows you to exclude up to $250,000 ($500,000 for certain joint returns) of gain realized on the sale of property if the property was “owned” and “used” as the taxpayer's principal residence for at least two years during the five-year period ending on the date of the sale. Gain realized from the sale of a home which is excluded under the exemption is also not subject to the 3.8% Obamacare tax.
More specifically, during the five-year period ending on the date of sale, you must have owned the residence for periods aggregating at least two years and also used it as a principal residence for periods aggregating at least two years. The periods of use and ownership need neither be continuous nor coterminous, provided each period totals two years.
It should be noted that the exemption does not apply to exclude the gain allocable to any portion of sold property that is separate from the dwelling unit (defined as a house, apartment, condominium, mobile home, boat, or similar property) and with respect to which a taxpayer does not satisfy the two-year use requirement. Therefore, if a portion of the property was used for residential purposes and another portion of the property, separate from the dwelling unit, was used for nonresidential purposes, then only the gain allocable to the residential portion is excludible.
On the other hand, if both the residential and nonresidential portions of the property are within the same dwelling unit, then allocation of basis and amount realized is not required (i.e., the entire amount of the gain is excludible, provided that the two-year ownership requirement is satisfied).
To the extent the gain from the sale of your residence exceeds the exemption amount, the excess should generally be taxed at beneficial long-term capital gains rates. Given that the UK exemption, discussed below, has no limit, it is often the case the sellers will need to consider planning to reduce the US taxes on the excess. Strategies, such as gifting to a non-US relative, should be discussed with your tax advisor prior to the sale of your residence.
Selling Your Foreign Property – the UK Tax Exemption
On the UK tax side, you’re entitled to full “private residence relief” from UK capital gains tax (“PRR”) when selling a so-called dwelling house if these conditions are met:
- the dwelling house has been your only or main residence throughout your period of ownership
- you have not been absent, other than for an allowed period of absence or because you’ve been living in job-related accommodation, during your period of ownership
- the garden or grounds including the buildings on them are not greater than the permitted area
- no part of your home has been used exclusively for business purposes during your period of ownership - this includes working from home using a room that is not exclusively used for business purposes
In describing a “dwelling house,” HMRC has clarified that it may be a single building, for example, a detached house. It also may be more than one building, for example, a house with a detached garage, or it may be a part of a building, for example, a flat.
Similar to the U.S. tax exemption, if your home includes more than one building, for example, if it has several outbuildings, any relief available for your dwelling house might not extend to all of the outbuildings.
If the dwelling house has not always been your only or main residence, you’ll need to split the gain. When calculating the proportion of the gain eligible for relief, you multiply the gain by a fraction equal to the periods of occupation divided by the period of ownership. The final 18 months of your period of ownership always qualify for relief, regardless of how you use the property in that time, as long as the dwelling house has been your only or main residence at some point.
HMRC has also clarified that if you live in, as your home, 2 or more houses, you can only have one main residence at a time for PRR purposes. However, you can nominate which residence is to be treated as your main residence for any period. If you do not make a nomination, the question of which is your main residence will be determined on the facts.
To the extent PRR is not available and the sale of your house is subject to UK tax, any U.S. tax paid on the sale of your residence should generally be available as a tax credit against your UK tax liability.