Owning property abroad does not take you off the US tax rolls: how foreign real estate is taxed in the US starts with the rule that citizens and resident aliens owe federal income tax on worldwide income, so rental revenue, capital gains, and even currency swings on an overseas property all belong on your Form 1040. Whatever you pay the local government is a separate matter, addressed later through the foreign tax credit. On top of the income tax, foreign holdings pull you into a set of information-return obligations whose penalties can run into five figures even when no tax is due.
Rental Income, Deductions, and Depreciation
Gross rental income from a foreign property is US taxable income, reported on Schedule E of Form 1040.1Internal Revenue Service. About Schedule E (Form 1040)2Internal Revenue Service. Foreign Currency and Currency Exchange Rates3Internal Revenue Service. Yearly Average Currency Exchange Rates Pick a method and stay consistent.
Most of the deductions available for a domestic rental apply here too: property taxes paid to the foreign government, management fees, insurance, maintenance, repairs, and mortgage interest on the loan against the property, subject to the usual investment interest limits. One deduction is off-limits. The Section 199A qualified business income deduction, made permanent by the One Big Beautiful Bill Act, only covers income effectively connected with a US trade or business, so foreign rental income does not qualify.4Internal Revenue Service. Qualified Business Income Deduction
Depreciation Runs on a Slower Schedule
Depreciation is usually the largest deduction, and foreign property runs on a different clock than US property. Tangible property used predominantly outside the United States must be depreciated under the Alternative Depreciation System. Under ADS, foreign residential rental property is depreciated straight-line over 30 years; foreign nonresidential real property uses a 40-year recovery period.5Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System There is no salvage value and no accelerated method. Before you claim anything, you have to split the purchase price between non-depreciable land and the depreciable structure, and that allocation needs to be reasonable and documented because the IRS can challenge it.
Passive Loss Limits
Foreign rental real estate is a passive activity. Passive losses can only offset passive income from other sources, and any unused loss is suspended and carried forward until you generate passive income or sell the property in a fully taxable transaction. There is a partial exception: if you actively participate in managing the rental, you can deduct up to $25,000 in passive rental losses against non-passive income, but that allowance phases out between $100,000 and $150,000 of modified adjusted gross income.6Internal Revenue Service. Instructions for Form 8582 Active participation is a lower bar than the “real estate professional” standard, but it still requires genuine involvement in tenant, repair, and lease decisions.
The 3.8 Percent Net Investment Income Tax
Foreign rental income and gain on the eventual sale can also trigger the 3.8 percent Net Investment Income Tax under Section 1411. It applies to individuals with modified AGI above $200,000 (single) or $250,000 (married filing jointly), thresholds that are not indexed for inflation.7Internal Revenue Service. Questions and Answers on the Net Investment Income Tax The tax is calculated on the lesser of net investment income or the amount by which modified AGI exceeds the threshold.
Here is the part that catches people. The IRS’s position is that Section 901 foreign tax credits cannot reduce your NIIT liability, because the credit runs against Chapter 1 income tax rather than the separate Chapter 2A surtax.7Internal Revenue Service. Questions and Answers on the Net Investment Income Tax Some taxpayers have challenged this in the Court of Federal Claims on treaty grounds, but those cases are pending appeal and the IRS has not moved. Plan on the NIIT as a real cost that the FTC will not offset.
The Foreign Tax Credit
When both the foreign country and the US tax the same income, the Foreign Tax Credit prevents outright double taxation. Individuals claim it on Form 1116.8Internal Revenue Service. Foreign Tax Credit
Only foreign taxes that function as income taxes qualify. Property taxes paid to a foreign municipality, VAT, and transfer taxes are not eligible for the credit. Those non-income taxes may still be deductible against rental income on Schedule E, but they will not reduce your US tax dollar for dollar.
The credit is capped at the US tax attributable to your foreign-source income. If the foreign rate is lower than your effective US rate, the FTC eliminates the overlap. If the foreign rate is higher, the excess credit carries forward for up to ten years. The one-year carryback that existed before 2018 was eliminated, so unused credits only move forward.
The limitation is calculated separately for each category, or “basket,” of foreign income. Rental income falls into the passive category basket, and excess credits in one basket cannot offset US tax on income in another. Overpaying foreign tax on rental income will not help with US tax owed on foreign wages or active business income.
You can choose to deduct foreign income taxes as an itemized deduction instead of claiming the credit, but the election applies to all foreign taxes for the year. A credit reduces tax directly; a deduction only reduces the income the tax is computed on. The deduction generally makes sense only in a year the credit would be worthless anyway.
Selling the Property
A foreign property sale involves more moving parts than a domestic one, because both appreciation and exchange-rate movement create taxable amounts.
Capital Gain and Recapture
Your gain is the difference between the US dollar amount received on the sale date and your adjusted US dollar basis, set using the exchange rate on the purchase date. Real estate held more than one year qualifies for long-term capital gains rates. Depreciation you claimed during the holding period is recaptured as ordinary income up to the amount of the gain, taxed at a maximum 25 percent rate. The recapture applies to the full cumulative ADS depreciation, which converts part of what would have been long-term gain into higher-taxed income.
The Section 988 Currency Piece
Currency movement creates a separate layer. Section 988 treats gain or loss caused purely by exchange-rate changes as ordinary income or loss, not capital gain.9Office of the Law Revision Counsel. 26 USC 988 – Treatment of Certain Foreign Currency Transactions In practice, you split the total gain in two: the real estate gain measured in the foreign currency and then translated to dollars, and the residual attributable to the currency moving against the dollar over the holding period. That residual is Section 988 ordinary income.10Internal Revenue Service. Overview of IRC Section 988 Nonfunctional Currency Transactions It is one of the less intuitive features of a foreign property sale, and it can meaningfully increase the effective tax rate.
Section 121 and Section 1031 Are Mostly Off the Table
The Section 121 exclusion of up to $250,000 in gain ($500,000 for married couples filing jointly) on a principal residence applies to foreign property in principle, but only if you owned and used it as your main home for at least two of the five years before the sale.11eCFR. 26 CFR 1.121-1 – Exclusion of Gain From Sale or Exchange of a Principal Residence Most investment properties abroad will not meet that test.
The Section 1031 like-kind exchange is unavailable. The statute expressly treats US real property and foreign real property as not like-kind.12Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment You cannot swap a foreign property for a US one, and the exclusion covers all property located outside the United States, so even swapping between two foreign properties does not work.13Internal Revenue Service. Like-Kind Exchanges Under IRC Section 1031
The Reporting Stack
Even a property that breaks even can generate several information returns. The penalties here are the sharpest edge of the whole area, because they apply regardless of whether tax is owed.
FBAR (FinCEN Form 114)
Any US person with a financial interest in foreign financial accounts whose combined value exceeds $10,000 at any point during the year must file the FBAR electronically with FinCEN, separately from the tax return.14FinCEN. Report Foreign Bank and Financial Accounts The FBAR does not report the property itself; it captures the foreign bank accounts you use to collect rent, pay expenses, or hold sale proceeds. The non-willful penalty runs up to $16,536 per report for 2026, and after the Supreme Court’s 2023 decision in Bittner v. United States, that cap applies per report rather than per account.15Internal Revenue Service. Report of Foreign Bank and Financial Accounts (FBAR) Willful violations carry the greater of $100,000 or 50 percent of the account balance, plus potential criminal exposure.
FATCA (Form 8938)
Form 8938, filed with your tax return, reports specified foreign financial assets.16Internal Revenue Service. Summary of FATCA Reporting for US Taxpayers Direct ownership of foreign real estate is not a specified foreign financial asset. If you hold the property through a foreign entity, however, your interest in that entity is, and the entity value counts toward the thresholds.17Internal Revenue Service. Do I Need to File Form 8938, Statement of Specified Foreign Financial Assets The thresholds depend on filing status and residence:
- Single, living in the US: total value exceeds $50,000 on the last day of the year or $75,000 at any point during the year.
- Married filing jointly, living in the US: total value exceeds $100,000 on the last day of the year or $150,000 at any point.
- Single, living abroad: total value exceeds $200,000 on the last day of the year or $300,000 at any point.
- Married filing jointly, living abroad: total value exceeds $400,000 on the last day of the year or $600,000 at any point.
Entity-Level Returns
Each type of foreign entity brings its own return, with penalties that do not care whether the entity earned anything:
- Foreign corporation, Form 5471: $10,000 per form per year, with additional $10,000 penalties for each 30-day period of continued failure after IRS notice, capped at $50,000.18Internal Revenue Service. International Information Reporting Penalties
- Foreign partnership, Form 8865: same $10,000 base penalty and escalation for US persons with a 10 percent or greater interest, plus a separate penalty of up to 10 percent of contributed property value (capped at $100,000 unless intentional) for unreported contributions.19Internal Revenue Service. Instructions for Form 8865
- Foreign disregarded entity, Form 8858: required annually for US owners; penalties fall under the same Section 6038 framework.20Internal Revenue Service. About Form 8858, Information Return of US Persons With Respect to Foreign Disregarded Entities and Foreign Branches
How the Ownership Structure Changes the Filing Load
Holding the property in your own name (or jointly with a spouse) is the simplest arrangement. Rental income and expenses flow directly to Schedule E, and no separate entity form is due beyond the tax return itself, though FBAR and, where relevant, Form 8938 still apply.
A foreign single-member LLC can elect disregarded-entity treatment by filing Form 8832, which pushes income and expenses back onto Schedule E as if you owned the property directly.21Internal Revenue Service. About Form 8832, Entity Classification Election The tradeoff is an annual Form 8858.
Holding through a foreign corporation adds real complexity. When US persons own more than 50 percent of the total voting power or value of a foreign corporation’s stock, it is a Controlled Foreign Corporation, and US shareholders can be pulled into current inclusion of Subpart F income and net CFC tested income (the regime formerly labeled GILTI), whether or not cash is distributed.22eCFR. 26 CFR 1.957-1 – Definition of Controlled Foreign Corporation23Office of the Law Revision Counsel. 26 USC 951 – Amounts Included in Gross Income of United States Shareholders24Office of the Law Revision Counsel. 26 USC 951A – Net CFC Tested Income Included in Gross Income of United States Shareholders For most individual investors with a single rental abroad, the compliance load from Form 5471 (and possibly Form 8938) outweighs whatever liability protection the corporation provides.
Inheritance and Expatriation
When a US person dies owning foreign real estate, the property is included in the gross estate for federal estate tax. Section 1014 provides a step-up in basis to fair market value at the date of death, and the statute does not distinguish between domestic and foreign assets.25Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent The step-up wipes out the built-in capital gain and resets the depreciation clock for the heirs.
If you receive a bequest valued at more than $100,000 from a nonresident alien, you must file Form 3520.26Internal Revenue Service. Instructions for Form 3520 Form 3520 is an information return and does not by itself create tax on the inheritance, but the penalty for failing to file can reach 25 percent of the unreported amount.
If you later renounce citizenship or surrender a green card after being a long-term resident, the expatriation tax under Section 877A can reach foreign real estate. A covered expatriate is treated as having sold all worldwide assets at fair market value on the day before expatriation, with gain reduced by a $910,000 exclusion for 2026.27Internal Revenue Service. Expatriation Tax You are a covered expatriate if your average annual net income tax liability for the five preceding years exceeds an inflation-indexed threshold, your net worth is $2 million or more on the expatriation date, or you fail to certify five years of tax compliance on Form 8854. Payment of the tax attributable to the deemed sale can be deferred with interest.
The State Tax Layer
Federal rules get most of the attention, but the state return is a second front. Most states with an income tax require you to report worldwide income, foreign rentals and capital gains included. The problem is that many states do not offer a credit for income taxes paid to a foreign country. Credits for taxes paid to other US states are common; the foreign tax credit is a federal concept that does not automatically carry over. Where your state provides no such credit, you face genuine double taxation at the state level that the federal FTC cannot fix. Confirm your state’s treatment before you assume foreign taxes will offset at both levels.