TKMAXX123

Hi,

My wife and I are moving in April this year to NJ. Unfortunately our companies were tight and aren't paying for tax advisors. Therefore I would really appreciate if people could recommend IFAs who are qualified in both the UK, and USA, with a focus on NJ / NY as this is where we're looking to move. We plan on returning in a few years' time but understand that there is a huge risk that we get things wrong during our time there, leading to fines or unnecessary taxes vs. sorting it out before we move!

We have also identified the following topics as things we need help from, and have specific questions. If anyone has a list of things that we need to make sure we sort out before the move to add, that would be great!
1) Setting up current residential property for overseas landlord tax / paying USA taxes on this rental income and claiming foreign tax credit
2) Structuring our S&S ISAs in such a way to avoid PFIC reporting requirements and minimise taxation from IRS
3) How to ensure we claim FTC for this year to minimise double taxation between UK and USA for January to April?
4) How to manage mortgage for current residential property to avoid currency fluctuation gains tax exposure - specifically, does this apply to rental properties if the property becomes a letting?
5) How to consolidate financial accounts to make FBAR/FATCA reporting as simple as possible - and what will we need to record to submit in the files?
6) Long term ramifications of staying in the USA e.g., capital gains tax exposure, mortgage currency fluctuation gains, loss of ISA benefits etc.

Thanks in advance for any pointers in the right direction - it's beginning to dawn on us just how complicated US taxes are, and that there will be severe penalties to staying long term e.g., capital gains tax on the UK property,

durham_lad

I can't help with most of your questions (my company did provide FA's to do our taxes). But, I'm pretty sure there is no way around holding funds in S&S ISAs without hitting PFIC issues. My advice would be to either only hold individual company stocks or simply convert to a cash ISA before moving. (The tax free wrapper of an ISA is not recognized by the IRS)

All of your questions are good ones to have answered.

TKMAXX123

Thanks. Yes we will avoid be investing in funds, but just stocks/bonds or even putting them into a cash ISA. Not sure if innovative ISA counts for PFIC.

Would you recommend the FA that your company provided? If so could you send me their details?

Glasgow Girl

1] From an IRS perspective there is nothing special to do on renting out a UK property, so long as it is held in your own name and not in a legal entity like an LLC. Just be sure to declare all income and expenses on your normal tax return. Online tax packages like Turbo Tax will guide you through the process when you file your taxes. Just watch out for Capital Gains Tax if you end up selling your home after you have been here for a while and no longer qualify for the Capital Gains Exclusion.

2) To avoid PFIC reporting and taxation make sure your ISA only has cash, bonds, or shares held directly in a company listed on a recognized stock exchange. You will pay tax at your highest marginal tax rate on any interest, short term capital gains and non qualified dividends held within your ISA, and capital gains taxes on any long term gains or qualified dividends. In general long term capital gains rates are better at 15% versus your marginal tax rate. In a nutshell non qualified dividends are dividends from shares held for less than 60 days, or dividends from non US companies, although that is over simplifying it. I believe an innovative ISA will be treated like cash or a bond, so not a PFIC (assuming it is one of those that are essentially loans).

3) You should not be subject to US tax until you arrive here as a resident, so there should be no double taxation other than UK tax paid on UK derived income after you arrive here. Again, the online tax preparation programs will walk you through claiming the appropriate FTC or deduction, it will recommend what is best for you. Not a big deal.

4) If the exchange rate right now provides less USD to the GBP than when you originated the mortgage then you could refinance to lock in a more advantageous starting point for the foreign currency gain calculation, but only you can determine if the cost will outweigh any potential benefit. The foreign currency gain will apply to all properties, rental or personal residence.

5) FBAR/FATCA reporting thresholds are on the aggregate balance so consolidating accounts does nothing to change that. You have to report the maximum account balance for each individual account, and other administrative details but although tedious it is not difficult. However the less accounts you have the less tedious it is. Look at the FBAR and FATCA form 8938, to see what information is required, but it’s pretty minimal.

6) You can protect yourself best by selling your UK property in a timeline that ensures you qualify for the Capital Gains Exclusion which general means you have to sell within 3 years of arriving here, to meet the requirement for it to have been your principal residence for 2 of the prior 5 years. Mortgage gain is covered above. Dump any PFICs BEFORE you arrive, no matter what. You will be wrapped around the axle reporting on them, likely have to pay for professional help, and paying outrageous tax rates.

durham_lad

They used their corporate accounting firm, Deloitte, to do our taxes. It was mainly to protect themselves as we were paid expenses, and given various allowances such as rent and to buy appliances, grossed up for taxes. Deloitte are way too expensive I think for an individual to use.

Pulaski

The US tax treatment of rental income is more generous than in the UK, and your taxable income is calculated to be net of pretty much any expense you incur, including but not confined to: mortgage interest, insurance, property taxes (if any), property management fees, advertising/ marketing expenses, repairs, maintenance, depreciation (see below for more info), etc. Depending on the market rents and how much mortgage interest you are paying (a function of both interest rate and size of loan), you may find that your taxable income is very low, and could even be zero - do not be concerned by this, it is perfectly normal, and must not deter you from calculating your taxes based on the tax rules and the numbers, including mandatory depreciation, not on the basis of thinking "that can't be right!"

Depreciation is mandatory, and for a house outside the US this is calculated straight line over 40 years (i.e. 2.5% of the applicable cost per year) and is calculated on the cost (to you) of the building but not the land. Assuming you don't have access to this split, you will need to estimate the proportion attributable to the building, and for an average house in the 'burbs 80% is a good starting point. If your home is on valuable land, for example if nearby properties are being demolished to build flats or if the city planners are allowing residential building to be replaced with commercial buildings then the proportion of the cost attributable to the land might be higher. Under some circumstances the cost attributable to the land could be less than 20%. And so far as this being mandatory, bear in mind that when you sell the property the capital gains calculation includes mandatory claw-back of the depreciation even if you did not claim it against income you received in the years when you were receiving rental income, so you're putting yourself in an expensive position if you don't deduct the relevant amounts of depreciation.

Oh, and if you're renting your home including appliances or other equipment, such as kitchen appliances, furniture, etc., then you get 20% per annum depreciation on that too (unless the 100% in the first year rule still applies? ).

TKMAXX123

Thanks for tbe detailed reply on this topic. We ran some numbers and the deductions were very generous. It will almost certainly be lower than our UK taxes. On depreciation, the flat is part of a complex. I might have a document somewhere that describes the building insurance value of the flat, but this might not be accurate as it is a limited view of the building value. And thanks for noting the implications for capital gains. If we are staying and selling we will definitely sell it before the 3 year deadline to avoid any issues.

And on the home appliances, this will be very hard as the flat is a new build so the appliances came bundled! We can estimate the original retail price or the insurance value. But depreciating those appliances really does help.

TKMAXX123

Thanks for such a detailed reply!

1. rent sounds simple and this hopefully will be very small as a previous poster noted. I am concerned that NJ does not allow a tax credit for foreign taxes paid on this income which seems unfair!
2. Yes definitely we will invest only in shares, bonds or cash. Interesting point on qualified dividends and I will investigate that as it opens the door to a wider range of investments.
3. I was under the impression that the USA will try and tax all my UK income earned for Jan to April if we move in April and become resident at that point. I will ask my future FA on this but do you think it is not true, and we only lay US taxes on income earned once we become US resident from that day on?
4. Yup I will basically let the mortgage go to thr standard variable rate and only remortgage until the pound buyers 1.4 USD again. I hope this is the case in 2 years time and we don't see any Brexit or Financial Crises style drops
5. Thanks, this sounds relatively boring but straightforward
6. Yup my wife and I will decide if we want to stay long term at the 2 year mark and then decide whether to sell the flat or not!

Pulaski

Don't stress too much about the split of building v land values - for a flat it is unlikely that the building will deviate far from about 80% of the aggregate cost of the flat plus share of the land value, because as the value of the land on which the flats were built increased, the number of flats the developer puts on that land tends to increase - e.g. if developers can fit 20 flats onto land that cost them £1 million, they would seek to put 40 flats on land worth £2 million, so the ratio is self-moderating in most cases. Bear in mind that even if the is no CGT payable there will still have been depreciation deducted from your gross rent received and therefore clawed back at the time of sale.

TKMAXX123

I see you what you mean. Just to play around with the numbers. Assume a £500k, $700k flat at time of purchase. Ignore FX fluctuations. To offset income tax on rental income we can reduce the income by deducting lets say 80% of $700k divided by 40. So deduct $14k every year from income... that really helps cut marginal income tax... however in the future if you sell the flat for over $700k you then have to pay the tax on the $14k times number of years depreciated previously. But this rate is 25% maximum which is lower than marginal federal tax rate for many expats so its better to depreciate as much as possible a) because it saves more tax and b) you might not even sell whilst US resident so no unrecaptured taxes in any case!

Thanks for the tip, I will definitely keep this in mind when filing the first set of taxes.

Pulaski

Yup, you've got it.

Then there's the esoteric matter of a possible capital gain, per the US IRS, when you repay the mortgage, upon sale of the property or refi of the mortgage. This is a possible capital gain on the loan, and is separate from the capital gain on the property, but this only applies if the value of pound sterling was higher at the time of the origination of the mortgage than at the time the mortgage was repaid. Honestly I am not certain if this is covered by the relief granted to a gain on your home, or not.

TKMAXX123

Yes this is one of my main questions for my IRA. I have consent to let on a residential mortgage for 2 years. If in 2 years time we still need to rent it out then we might have to refinance onto a buy to let. But, let's say that the loan is £400k so $560k at 1.4, then if the pound is only 1.3 then the value is $520k, but I have already paid off perhaps $30k, so the value is actually $490k. I can imagine it being a pain to sort this out and argue the gain is only $40k.

I might be better of sticking with the flat being not rented out until the pound strengthens or even just breach the residential mortgage t&c given that the IRS punishment (huge tax liability and fines) is far worse than a banks (forced redemption of the mortgage which i would have to do at some point anyway).

having taxes on phantom gains on a property bought before entering the US is insane. Are you saying that it would be capital gains and not income tax?

Glasgow Girl

Foreign currency gains on a mortgage are taxed as ordinary income, so basically at your highest marginal tax rate, plus state tax. You will “only” have to pay tax on gains associated with the amount actually paid off, you won’t need to argue about the loan being smaller when redeemed versus originated. You could hedge your. bets, rent it for a year, see how it goes and then sell or not depending upon your long term plans and how the exchange rate is looking. Your crystal ball may be a bit clearer by then.

Glasgow Girl

1. You will probably be able to recoup all foreign taxes paid from the Federal tax so it won’t matter that NJ does not allow it. In any case if I recall correctly you can register to have your rent paid without UK tax being withheld, I am pretty sure I received it free of UK tax when I rented a UK property.
2. Beware that qualified dividends from a PFIC are treated quite differently than qualified dividends from US mutual funds.
3. So long as you are not a US citizen, the US will not tax any overseas income until you become a resident.

Pulaski

As I understand it, having never needed to do this calculation for my own taxes, you work back from the redemption amount to calculate the original "position", so it isn't as convoluted as you fear. Per your example, if the loan was £400k and the redemption amount is, say, £380k at 1.3 that's $494k, and the "original loan", per that redemption amount, is £380k at 1.4, so that's $532k, making the gain $38k. In other words, from the US IRS's perspective (which I agree, when you were not subject to US taxation at the origination of the loan, is nonsensical) you borrowed $532k and satisfied the debt in full with a repayment of $494k, thereby making a gain of $38k, and the original loan figure of £400k doesn't appear in the calculation at all.

Normal ongoing monthly loan payments are excluded from this convoluted calculation, but hypothetically if you decided to make an one-off lump payment to reduce your mortgage that would potentially create a taxable gain too.