For UK citizens selling a property in the USA, completing the sale is only your first hurdle. Your next challenge is tax – both in the UK and the USA – neither set of rules being straightforward.
Taking UK tax first, if you are resident and domiciled in the UK, you will have capital gains tax (CGT) to pay on any gain achieved on the sale of US property. The gain is calculated by taking the gross proceeds, then deducting the original cost of the property and any other relevant expenses – legal fees, local taxes, improvement costs etc. In arriving at these figures, all amounts would need to be converted from US$ to UK Sterling at the prevailing exchange rates at the date of each transaction for UK tax purposes. For example, if the gross proceeds on sale are US $750,000 then based on an exchange rate of $1:£0.801239, the gross proceeds for UK tax purposes are £600,929.
The resulting gain is then taxed at rates of 18%/28%. If, however, the costs exceed the proceeds, then there will instead be a capital loss.
As you would expect, there is also US tax to pay on the sale of property situated in the USA, but you will be entitled to claim a credit for the US tax suffered. This is deducted from your UK liability, so that you will not suffer double taxation.
To expand further on US taxes, FIRPTA (“Foreign Investment in Real Property Tax Act”) imposes a 15% withholding tax, which is taken from the gross proceeds on the sale of US real estate by foreigners. This withholding is reported on Form 8288 by the buyer and the tax is payable to the IRS within 20 days of sale. A statement of the withholding tax is provided to the seller on Form 8288-A. It is possible to reduce the withholding tax to the actual tax due on the sale, by submitting a calculation of the gain and the tax, together with Form 8288-B. In this case, 15% of the gross proceeds is still withheld, but once Form 8288-B has been processed, a refund of US tax is made.
Whilst it is possible to reduce the withholding tax by completing Form 8288-B, this does not avoid the obligation to complete a US tax return. In other words, a US tax return has to be completed in relation to all property sales.
Filing a US tax return can be beneficial. It may result in a tax refund, depending on the circumstances. For example, if there is a sale of one property at a gain and another at a loss, then filing a Form 8288-B alone will not take the loss into account when calculating the tax due on the property sold at a gain. In this case, it would be beneficial to file a US tax return to obtain a further refund of US tax.
Failure to comply with the FIRPTA provisions can result in the imposition of penalties against the buyer, who is made responsible for withholding taxes. In addition to the unpaid tax, the IRS can impose (1) late filing penalties (2) late payment penalties and (3) interest for late payment.
If the seller decides not to file a US tax return, then apart from the risk of being investigated and penalised by the IRS, there is a possible issue with the double tax relief claim in the UK. When a claim is made for foreign tax credit in the UK, HMRC expects the taxpayer to make every reasonable attempt to reduce their foreign tax liability. This provision is in place to prevent HMRC from losing out on tax revenue due to an excessive foreign tax credit relief claim. The 15% withholding tax on the gross proceeds (where neither a US tax return or Form 8288-B is completed) will be more than the actual tax due on the gain. Filing a US tax return would result in a refund of US tax and thus a lower US tax liability to claim as a credit against the UK tax liability. In other words, HMRC could argue that a foreign tax return should be completed, as this is the definitive way to calculate what the foreign tax credit should be.
In recent years, HMRC have increased their scrutiny of claims for foreign tax credit relief. There is now a significant risk of them challenging claims where they believe the foreign tax credit relief claim is too high. A successful challenge by HMRC will mean further tax to pay and other liabilities, including interest charges and possible penalties – not to mention the excess US tax that you have suffered.
There may be other issues to consider, including but not limited to the following:
- Possible US state taxes on any gain.
- Applying for an Individual Tax Identification Number (ITIN) in order to file a US tax return.
- Tax domicile: if you are not UK domiciled, you might be able to claim the remittance basis, where no UK tax is payable on the gain, provided you do not remit the proceeds to the UK.
- Whether it would be tax efficient to claim the US tax as a deduction instead of as a credit against the UK tax. Generally, it is tax efficient to claim relief by way of credit but in some limited circumstances, it might tax efficient instead to claim the US tax as a deduction from the gain. For example, if by claiming a deduction this would create a capital loss which can then be offset against other capital gains.
- Whether the property disposal falls within one of the five exemptions from FIRPTA.
If you would like assistance with any of these matters – or indeed other tax issues – please contact your Prager Metis advisor.
