Craftycow

We moved to Arizona from the UK 2 years ago with my husband's job and this will be our 2nd US tax filing. My mother passed away in the UK last year and I inherited £110K from her estate, which is below the threshold for inheritance tax. We thought it would be a good idea to use this money to pay a lump sum off our UK mortgage and did so in December 2016. It is a repayment mortgage with no penalties for overpayments and we elected to keep repayments the same so that it would be paid off in 3 more years. All good ... or so we thought.
The accountants who have just completed my husband's tax return (which is in joint names although I have not worked since we have been here), have now advised that this lump sum payment is counted as a 'gain' for US tax purposes and is subject to US tax. They have advised that worse case this could be as much as $9K!! Is this correct? It seems very unfair to me that money left to me by my late mother in the UK and paid into a UK mortgage account (which incidentally is actually documented as an 'overpayment' by the Nationwide and has not changed the term or monthly repayments at this point as theoretically we could choose to take it out again if we wished ... too late for previous tax year though apparently), is not subject to any UK taxes but now we have to pay tax on it here in the US? It seems a very bitter pill to swallow and had we known would have just left it in another savings account where apparently it would not have been subject to any tax! Has anybody else experienced this scenario?
Thank you for any advice anybody may be able to share.

ian-mstm

When I inherited about £40K from my uncle's estate, the money was taxed in the UK before being sent to me. The money was therefore exempt from US taxes. The US/UK tax treaty usually helps you avoid double taxation.


Ian

nun

This has nothing to do with inheritance and every thing to do with the fall in the value of the pound and foreign exchange gain....see here

Foreign Mortgage Repayment and Exchange Rate Gain - US Tax & Financial Services

Craftycow

Thanks so much for this - now at least, whilst still miffed to say the least, I understand that this is exchange rate related and not so much to do with the lump sum itself. Wish I'd known about it before we did it though. So if we moved back to the uk in another 12 months assume we don't get that back? Hahahaha ... **cue hysterical laughter**

Steve_

You also have to report the inheritance to the IRS - complete part IV of Form 3520: https://www.irs.gov/pub/irs-pdf/f3520.pdf

nun

....and watch out for FBAR and 8938 reporting if the money was held in probate for your benefit.

Craftycow

Cosmic. Thanks

Craftycow

Thank you, it wasn't though. Deloitte are competing our tax return so hopefully all covered but I just wanted to check re the whole mortgage issue.

Cook_County

You will want to ask Deloitte in Hyderbad:
1. Why did they not tell you before the transaction happened.
2. If they considered you jointly electing to file for the complete year of arrival to maximise foreign tax credit carryovers. This is standard planning.
3. If they are taxing the currency gain as ordinary income or as a capital gain & what the difference is in number terms.


You will want to look also at your employment contract to see if the employer will pay host country taxes at all where these exceed home country taxes.

Craftycow

Thanks (not sure where Hyderabad comes in though? We are dealing with Deloitte in the US as part of relocation package). I am still struggling to understand though how this 'foreign exchange' gain applies when the mortgage was taken out 12 yrs ago in the UK, where we lived until 2 yrs ago, inheritance was paid in the UK in GBP into my UK bank account and then paid into our UK mortgage account. At no time was the money in the US, neither are we permanent residents of the US as currently on L1/L2 visas.

nun

But you are US tax residents and so liable to US tax on your worldwide income. The tax on the lump sum mortgage payment arises from the capital gain implied by the difference in the dollar to pound exchange rate between when the property was initially purchased and the rate when the lump sum payment was made. The post Brexit fall in the value of the pound has increased that capital gain.

Paying off foreign mortgages or selling foreign property can be a tax trap for US residents which is why it's often prudent to do it before you become US resident.

Craftycow

But we are technically not US residents?

Craftycow

Ok think you mean for tax purposes, in which case you are correct. Bummer!

davenay67

The OP inherited 110,000 GBP from their mother. In their situation they used that money to pay down their existing UK mortgage, which triggered a capital tax gain due to the currency rate difference. I understand the logisitics of the article that was posted by nun, although I have a hard time believing this is fair. It's not as though they made actual profits (like a ForEx transaction for example). Their house is not any more valuable as a result of the lump sum payment; the OP simply owes less on the principal of that mortgage.

If they had kept the inheritance money and simply put it in the bank instead:-
1) Would they would now have to report the new balance of that account via FBAR?
2) I thought FBAR was for US citizens living outside the USA?
3) If they split the money across multiple accounts (to keep individual balances under $10K) would they still have to report FBAR?
4) Would there be any US tax implication for receiving this money seeing as it falls under both the UK and US inheritance limits, and the original money presumably was subject to UK tax in the first place when earned by the mother?

Sorry for the multiple questions, but the scenario above seems yet another weird way for the IRS to get their hands on peoples money..!!

theOAP

"Fair" doesn't enter into the equation. The IRS and US Congress believe this is very much the right way to approach those with foreign assets. Perhaps a better question would be "is this morally correct?" Again, the IRS and Congress would think so. In their eyes, the taxpayer should be aware of the consequences of owning foreign assets when they qualify as a 'US Person' for tax purposes.

1) Yes
2) FBAR is for any US Person. For a US Person, it doesn't matter where they live, and that includes outer space.
3) Yes, it's the aggregate amount of all accounts.
4) For the recipient, (likely) in this case, the inheritance itself is tax free (but interest on the funds may be taxable). If the person who died had been a US Person, but who had renounced US citizenship as a covered expatriate, the beneficiaries, if US Persons, would owe a tax of 40% minimum.

We really do need a sticky somewhere on this site about the consequences of owning foreign assets as a US Person.