The
JacobsReport
is a free email newsletter that will discuss investment, business, tax
and financial planning in an international context. Reports will be
issued
as the author's work schedule permits, but will usually be issued on a
weekly schedule.
Currency Gain on
Sale of a Foreign Residence
QUESTION: I
recently
purchased your book for a specific item I wanted to check on regarding
foreign
currency gains/losses. I did not find this in the book, so I
wanted to
ask you about this.
If a foreign
residence were sold in 2004 by a US
resident for which applicable taxes were
paid, & the proceeds were kept in UK pounds, with the pounds
converted to dollars in 2006 at a gain (difference between the 2004 and
2006
exchange rate), would this gain be taxable as a foreign currency gain
in 2006?
The reason I
asked is the comment in your book as follows:
The
general rule with regard to the U.S. tax treatment of gains or
losses from exchanging U.S. currency for non U.S. currency (and
back) is
that the gain or loss on the currency exchange will now be taxed the
same as
the underlying transaction.
Being the
currency was not converted from dollars to pounds
and back as specified in your book, I thought that possibly this would
not be
subject to a taxable gain. If taxable, would it be a capital or
ordinary gain.
REPLY: Hopefully, you were aware
that a gain on a personal
residence could be eligible for tax free treatment of up to $250,000
per
taxpayer, even if it is a foreign residence. Section 121 does not
exclude a
foreign residence from this tax benefit, although it does preclude the
use of
this tax break for a person who has relinquished their citizenship or
permanent
residence status. With respect to the portion of any gain resulting
from changes
in the value of a foreign currency, it seems to me that the gain is
based on
the amount received in U.S. dollars minus the amount paid in U.S.
dollars. If
the sale proceeds are not converted to U.S. dollars, it seems to me the
excludable gain is based on what the proceeds are worth in dollars at
the time
of the sale.
The gain
(whether taxable or excludable) would be based on
the dollar value of the sales proceeds. Any further gain resulting from
holing
the proceeds in the form of U.K.
pounds would be treated as a capital gain at the time the pounds were
converted
to dollars.
With respect
to investments, it seems to me that the cost of
the investment is based on the cost in dollars at the time of purchase
and that
the sales proceeds are based on the dollar value of the sales proceeds
even if
the sale is made in a foreign currency and is not converted into U.S.
dollars.
However, I
have not been able to find any explicit authority
to support my interpretation. The rules are ambiguous and do not
directly
address the question of whether currency gains and losses are treated
separately from the total gain or loss on an investment acquired and/or
sold in
a foreign currency. The primary tax code section that deals with
currency gains
or losses is section 988. The related IRS regulation is Reg. section
1-988-0,
which consumes about 64 pages of fine print. In past occasions and in
responding to this question, I could not find any explicit reference to
the tax
treatment of currency gains or losses as being separate from the total
gain or
loss on an investment. The focus of section 988 is on currency gains or
losses
resulting from the conduct of a trade or business in a foreign country
and
currency. Section 988(e) provides an exception with respect to currency
gains
of up to $200 realized by an individual, which are not related to a
trade or
business (IRC 162) or to investment related expenses (IRC 212).
Currency gains
and losses on commodity hedging transactions that are subject to tax
code
section 1256 are included with the gain or loss on the underlying
contract.
As far as I
can determine, investments in foreign currencies
are treated the same as investments in capital assets such as corporate
stocks
but special rules apply to investments in foreign mutual funds (aka
passive
foreign investment companies). Debt obligations purchased by a
corporation
appear to be subject to the IRC 988 treatment which basically subjects
any gain
to ordinary income treatment.
For further
details, here are some web pages about currency
gains and losses.
http://www.offshorepress.com/offshoretax/otcurrency.htm
http://www2.law.cornell.edu/uscode/uscode26/usc_sec_26_00000988----000-.html
http://www.nysscpa.org/cpajournal/old/11356692.htm
http://www.greencompany.com/EducationCenter/GTTRecCurrency.shtml
http://answers.google.com/answers/threadview?id=470486
Vern Jacobs
If you find
this information to be helpful, a modest
contribution to Positive Lights, Inc. would be appreciated. (See www.positivelights.org)
Vern Jacobs