Taxation, particularly Capital Gains Tax, on a rental property in the USA

Question

I have a number of questions regarding the possible purchase of a rental property in Hawai’i. We are citizens and residents of Australia for taxation purposes. If it matters, we are also dual citizens of Canada. I am not sure how many related questions I am entitled to ask here, so I will firstly give some background on my knowledge so far, then ask my questions in order of their priority.

BACKGROUND KNOWLEDGE

– I am aware that the USA has a double-tax agreement with Australia. I know that we would file with the IRS declaring any rental income earned (deducting maintenance expenses against it), pay their tax bill, then claim that as a foreign tax credit after declaring the same rental income to the ATO. I believe that I can only claim foreign tax credits (from payments to the IRS) against the rental income, but that I can claim other foreign losses (negative rental income against employment income or general income.

MY QUESTIONS

The information above gives rise to some confusion about capital gains on foreign property:

– At the time of sale, I am assuming that I will pay CGT in the same way described above: To the USA first, then claiming that as a foreign tax credit against my Australian CG (minus the 50% discount). Is that correct?
– However, I have heard rumour that I cannot claim capital losses from a USA , if it comes to that. This seems like a contradiction.
– To what extent could we deduct travel and accommodation expenses to the USA against this property?
– If we operate the rental property through a Limited Liability Corporation (owned either by one or both of us), does that change any of the rules against our individual tax returns in either country?
– We already have a bank account in the USA, with a large sum already deposited. Have you heard of any Australians who have had difficulties with the American banks wanting to close those accounts?

I would also be interested in what you would charge per year to manage our IRS return, and to additionally manage our ATO return (assuming employment income, interest and this investment only). I imagine that you would need to provide those answers offline, though.

Answer

From the 1st July, 2008 foreign tax credits can offset the Australian tax payable on the same income; they cannot be used to offset tax on other income and they cannot be carried forward to offset in the future. To work out how much of the offset you are allowed to use (the offset cap) you can consider the foreign income that generated the credit to be your last piece of income for the year; in other words, subject to the highest rate of tax that applies to your income. Foreign losses are now allowed to be offset against Australian Income.
For the purposes of the tax return foreign capital gains are recorded with all other capital gains, not as foreign income. Any foreign tax credit for these capital gains can still be offset against the CGT in Australia. To ensure the best opportunity to offset these foreign tax credits you are allowed to consider the foreign capital gain last. This way any capital losses you have may be able to be offset against your Australian capital gains first, leaving the maximum amount of the foreign capital gain taxable so you can utilise the credits.

If you make a capital loss overseas this can only be used to offset capital gains so just as is the case with capital losses made in Australia it is carried forward until you make a capital gain. Whether that gain be made in Australia or overseas. IT2562 allows foreign capital losses to be offset against Australian capital gains first thus maximizing any other foreign capital gain and so maximising the opportunity to utilise the foreign tax credits from the foreign capital gain.

If you are entitled to a credit for foreign tax on your capital gain your tax return will need to be lodged manually with a note detailing this as there is no facility within a normal tax return to record the credit.

Keep a travel diary and apportion the costs on the basis of the days relating to the property and days for other purposes. If visiting the property is incidental to a holiday over there then you are not going to be able to claim the air fares. On the other hand if a couple of days R&R is incidental to the rental property you will be able to claim all the air fares. If it is not so one sided then the airfares are apportioned as per the diary.
I can’t answer questions about US tax law, we have an arrangement with BDO a large accounting firm who have specialists in this area.
Owning the property through a company in the US would change things but not avoid tax because you would be the controller. If anything it will just make things more complex.

Sorry have no idea about what the US banks are likely to do. We can’t do your US return again BDO could but I think it may be cheaper to get a local accountant over there to do it rather than what would need to be a specialist here.

Assuming you would present all the information in Australian dollars your Australian tax return would be no more difficult than a tax return with a rental property in Australia. Depending on the office you can expect about $100 for the rental schedule one only as it can be transferred into both tax returns. Individual tax returns are around $150 so in total around $400 for the both of you.

Please remember that this advice is provided just from the information you have supplied so does not take into full consideration all your circumstances. Accordingly, you should obtain advice from your own accountant before acting on it.

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