US tax issues when buying a French Property
4 Tax Issues for US Persons to Consider When Buying a French Property
If you are a US citizen or a US tax resident and you are thinking about buying a property in France, you should familiarize yourself with the French and US tax systems and how they interact. A good starting point to do this would be to read our free tax guide. Here we summarize four potential tax issues you may face when acquiring French real estate.
Exchange Rate Issues
We have seen how the US dollar has been getting stronger, hitting its highest level ever against GBP in recent days. Currently the Euro is worth less than 1 dollar whereas a year ago it was worth 1.17. This is a far cry from the value of 1.6 USD back in June 2008. While a strong dollar is good news for Americans who want to invest in European properties, the future of the USD/EUR exchange rate is difficult to predict, and you should be aware of the potential tax issues that a fluctuating exchange rate can cause.
Firstly, for US tax purposes any capital gain on disposal of the property in the future must be calculated using the applicable exchange rates at the date of acquisition and disposal as well as the dates any other relevant costs were incurred. If you buy a property for 500,000 EUR when the Euro is at parity with the dollar (500,000 USD) and sell it in 5 years for EUR 600,000, you will have a capital gain of 100,000 EUR. However, the USD gain for US tax purposes will depend on the exchange rate at the date of the sale. The impact of exchange rates can be huge. For example, if the dollar continues rising (e.g. 1 USD = 1.2 EUR) there would actually be a USD loss; whereas if the dollar goes back to 2017 levels (e.g. 1 USD = 0.8 EUR) the gain would be 250,000 USD.
This is not the only time that exchange rates can have an impact on the taxes you pay. If you are thinking about getting a non-US denominated mortgage to buy the property you should be aware of your exposure to mortgage exchange rate gains.
US tax law will require you to recognize an exchange rate gain on your US tax return where you pay back a loan that is cheaper in dollar terms when compared to its dollar value at acquisition. Such a US taxable gain could be the unexpected consequence of a sale of your French property. Imagine you took out a mortgage loan on a French château of 1,000,000 EUR on 01 January 2021 (1 USD = 0.8149 EUR) and you pay it back when the EUR and the USD are at parity. That means you will have a taxable exchange rate gain of 227,100 USD. The income is treated as ‘ordinary income’ in the US, meaning that it is taxed at the higher rates applicable to income rather than long-term capital gains.
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The following actions may reduce your exposure:
- Making periodic (e.g. monthly) capital payments. There is a de minimis exemption from the rule where a transaction results in a gain that is lower than 200 USD.
- Tracking exchange rates and making substantial capital repayments when the rate is advantageous (i.e. it results in no gain or a loss).
- Sharing the mortgage loan obligation with a non-resident alien. US tax non-residents are not subject to US income tax on their share of foreign exchange rate gains.
Both French and US domestic tax law allow tax relief when you sell a property which is your ‘primary residence’. However, the requirements for your home to be considered your primary residence differ:
- The US requires you to have owned and lived in your home for at least 24 months of the 5 years prior to sale.
- French law does not include a minimum period but requires that you occupy the home on a habitual basis until the house is sold with certain exceptions. Additionally, if you are not French tax resident when selling the property there is a requirement that:
- your sale is made no later than 31 December of the year following the transfer of your tax residence outside France, and
- the property has not been made available to a third party, whether free of charge or not, between this transfer of residence and the sale.
Please also note that the exclusions available are different. In the US, an exclusion of up to 250,000 USD of gain is available (500,000 USD where using ‘married filing jointly’ filing status on your US tax return) whereas in France the whole capital gain may be excluded. Also, both legislations include the possibility of getting a partial exemption. In the US a partial exemption is available only in limited circumstances (such as a change in place of employment, health reasons, etc).
Double Tax Relief
The timing of foreign tax payments and the elections you make are crucial to efficiently benefit from foreign tax credits (a form of double tax relief). If you report foreign taxes on your US tax return on the paid basis, you must ensure that the French capital gains taxes are paid in the same calendar year that the gain is realised to maximize your double tax relief. If the taxes are paid in a different year to the realisation of the gain, cash flow issues can arise and, in the worst cases, there will be double taxation. Reporting taxes on the accrued basis may eliminate the timing issues, but once this basis is elected, it cannot be changed without IRS approval. This accrued basis be convenient for reporting French taxes but there can be negative repercussions if, for example, later you decide to relocate to a country with a non-calendar tax year (e.g. the United Kingdom).
The issue with exchange rate gains (mentioned above) is that you may not have any foreign taxes to offset against the related US tax. This is because such gain is a phantom gain for US tax purposes only and would not be subject to French tax.
Also, there are taxes which do not attract foreign tax credit relief. The US net investment income tax (NIIT) is imposed at a rate of 3.8% on net investment income (including the taxable portion of any gain on the sale of your French property and exchange rate gains). Foreign tax credits may not be used to reduce NIIT. Additionally, if you are resident in a US state, that state may not allow foreign tax credits against its income taxes.
French Social Security
Should you receive rental profits from a French property or capital gains from the sale of that property, you will need to pay social security contributions. If you are affiliated to a compulsory social security system within the EEA, Switzerland or the United Kingdom you are exempt from paying the General Social Security Contribution (CSG) and the Social Security Debt Repayment Contribution (CRDS) but you are still subject to the solidarity levy (7.5%).
However, even if you are not exempt, US citizens and tax residents who pay/paid the contribution sociale généralisée (CSG) and the ‘contribution pour le reimbursement de la dette sociale’ (CRDS) in France may claim these amounts as foreign tax available to credit against their US income tax. The availability of CSG and CRDS as qualifying foreign taxes for credit purposes has only recently been established by the IRS and US taxpayers may wish to review their returns for the last 10 years to ensure they have maximised their credit position.
While this article gives useful pointers as to 4 of the tax issues you can encounter as a US person buying French property there are many more that should be considered. You may wish to explore further by downloading our free tax guide.
If you feel you need support with your French property acquisition, our team of cross-border tax experts will be happy to assist you.