Taxpat's US Tax Blog

Fines for (NL Residents with) Secret Bank Accounts to Triple

Scary news for those taxpayers still not reporting their worldwide assets in Box 3. If you are ready to come clean and want to take advantage of the amnesty program, there is a specific form to complete, called a "Vrijwillige Verbetering", which can be downloaded from the Belastingdienst web site at http://download.belastingdienst.nl/belastingdienst/docs/vrijwillige_verbetering_buitenlands_vermogen_ib151z3plfol.pdf.
Unfortunately the form seems to be available only in Dutch.  Note that tax paid in Box 3 is a "creditable" tax for US tax purposes, so playing it by the book usually doesn't give too bad of a result for US citizens, aside from avoiding penalties down the road.

Per DutchNews.nl (www.dutchnews.nl), Monday 06 April 2009:

The fine for people found to have secret bank accounts abroad is to be tripled to 300% of the non-declared savings, tax minister Jan Kees de Jager told tv show Buitenhof on Sunday.

At the moment, people found with secret savings face having all of the money confiscated by the tax authorities. If MPs back de Jager's proposals, they will also have to pay the same amount twice over in fines.

Since 2002, the government has operated an amnesty for people with secret accounts. If they admit to having money stashed abroad they have to pay an extra tax surcharge but no fine and will not face criminal prosecution.

So far this year 317 people have come forward, admitting to secret savings totalling some €70m.

Drug dealers

The Telegraaf reports on Monday that a considerable percentage of the people declaring their foreign savings are soft drugs traders who made their money in the 1990s.

'If they declare their money to the tax before an investigation is begun, they do not have to say where their capital came from,' one lawyer told the paper.

Since it emerged that Switzerland, Liechtenstein, Luxemburg and Andorra are reforming their bank secrecy laws, the number of people declaring their foreign accounts has gone up by 20 a day, the paper says.

Tax havens are coming under increasing pressure on their banking secrecy laws and world leaders agreed at last week's G20 summit in London to take tougher action against them.

David Colvin is a CPA and CFP® based in Amsterdam, Netherlands since 1998.  His niche focus is serving high-net-wealth individuals with cross-border tax and financial issues.  He is also an advisor to Maxim Global Wealth Advisors, based in Amsterdam and Portland, Oregon.

Is a Foreign Mortgage Worth the Risk?

Anyone who has asked me knows I am no fan of investing in real estate in (Western) Europe at the moment.  One of the biggest risks I see (aside from the fact that real estate prices have not "corrected" yet in many cities) is a little-known IRS law concerning taking out a mortgage in foreign currency. 

Sec. 985(a) of the Internal Revenue Code generally requires all income tax determinations to be made in the taxpayer's "Functional Currency", which for US citizens and greencard holders is always the USD, regardless of where they reside or how they are paid.  Sec. 988 of the Code covers "988 transaction", which includes the acquisition of debt in a non-functional currency such as becoming an obligor under a mortgage, and requires you to use your functional currency when determining a gain or loss on the mortgage. 

What does this actually mean for you?  It means that you need to convert the amount of the loan into USD at the time you borrow the money and again at the time you pay off the loan.  If there is a gain, this is taxable as ordinary income (not capital gain and not eligible for the $250K/$500K exclusion under IRC Sec. 121).  If you have a loss, this is considered a "personal", non-deductible loss (so basically the IRS gets the upside but not the downside).

This hasn't been much of an issue for the past several years, because the weakening dollar has created losses, which are not deductible.  Also, most taxpayers didn't even know they had a loss (because this law is pretty obscure) so they didn't feel like they missed out.  In addition, rising home prices have created gains (in both Euro and dollar terms) on most sales, so everyone's happy. 

So why is this a dangerous time to take out a foreign mortgage?  I can't predict the future, but my money is on the dollar strengthening over the next few years.  If this happens, you will start to see the ugly side of this law.  For example, if you borrowed EUR 1M today, you would be borrowing approx. $1,550,000.  Now assume you pay off this mortgage 10 years from now, and the dollar has strengthened significantly, back to 1:1 with the Euro (hey, it could happen!).  This means you only need to pay back $1,000,000 (in the eyes of the IRS).  In this case you have a $550,000 gain from paying off your foreign mortgage, taxable as ordinary income, so as high as 35% (or whatever higher rate may be in place at the time).  This means a potential tax of almost $200K, even if you actually lost money on the home sale, which I think is a "real" risk at the moment. 

Sound too bad to be true?  These rules are clearly laid out in Rev. Ruling 90-79, 1990-2 CB 187, and also in the 1996 court case "Quijano v. the United States" (96-2 USTC P 50,441), and don't leave much room for interpretation.

I'm not a fan of letting taxes rule your "life" decisions, but this one is definitely something to take into account if you are currently considering buying a property in Europe and don't have the cash to purchase without a mortgage.

David Colvin is a CPA and CFP® based in Amsterdam, Netherlands since 1998.  His niche focus is serving high-net-wealth individuals with cross-border tax and financial issues.  He is also an advisor to Maxim Global Wealth Advisors, based in Amsterdam and Portland, Oregon.

How is the Sale of a Foreign Personal Residence Taxed in the US?

One of the most common issues I see (and probably the one with the most impact) is the taxation on the sale of a foreign personal residence. 

US citizens (and greencard holders) are required to use the US Dollar as their "functional currency" for all "personal" transactions, including the purchase and sale of a foreign residence.  For most US expats, there are actually two separate taxable transactions that occur when you sell a foreign residence - "Capital Gain" from selling the residence, and "Exchange Rate Gain" from paying off a mortgage denominated in a foreign currency.

Taxation of Capital Gain:

The current tax rate on the gain from selling a personal residence is 15% (as long as you have held the property for at least a year).  The gain is calculated by translating the purchase price using the exchange rate at the time of the purchase, the cost of capital improvements using the exchange rate at the time the improvements were made and the exchange rate at the time of the sale, rather than by using the exchange rates at the time of sale in all three cases (C.J. Quijano v. US; 96-2 USTC P 50,441).  If you meet the requirements of IRC Sec. 121 (you owned and used the property for 2 of the 5 years prior to the sale or meet one of the exceptions), you are allowed to use the $250,000 ($500,000 if MFJ) exclusion available to properties located in the US.  If the result is a capital loss, this is considered a personal, non-deductible loss.

Taxation of Exchange Rate Gain:

The Exchange Rate Gain from paying off a mortgage denominated in a foreign currency is treated a separate transaction and is calculated by translating the amount of the loan using the exchange rate at the time the loan was originated and the exchange rate at the time of the loan was paid off.  The resulting "gain" is taxable as "ordinary income" using your marginal tax rate (maximum 35% for 2008).  Again, if the result is a capital loss, this is considered a personal, non-deductible loss.

Note that you cannot use the loss from the mortgage payoff (which is what most people have these days) to offset the capital gain from the sale of the home (Revenue Ruling 90-79, 1990-2 CB 187).

These rules may look harmless enough, but the results can be devastating and should be taken into account if you are considering selling (or before buying) a foreign residence. 

David Colvin is a CPA and CFP® based in Amsterdam, Netherlands since 1998.  His niche focus is serving high-net-wealth individuals with cross-border tax and financial issues.  He is also an advisor to Maxim Global Wealth Advisors, based in Amsterdam and Portland, Oregon.

Are Foreign Investments Legal for US Citizens?

Question : I am an American Citizen living in Asia. My question is am I prohibited by US law from investing foreign stocks,or mutual funds other type of financial investments. I have been told that as an American there are certain types of foreign investments that are prohibited but I have no definition of which.

Answer:  There is no law prohibiting investment in foreign stocks or mutual funds (as long as you report them properly), but there are several rules which make it disadvantageous for US citizens (especially for mutual funds), and the reporting requirements are pretty confusing, with large penalties for getting it wrong.  I’ve written an article I wrote on the subject that might be useful for you, which can be found on our web site (www.taxpat.com). 

My general conclusion is that for most expats it is better to invest via a US broker (e.g. E*Trade, TD Ameritrade, ScottTrade, etc.), where you can be assured that you are in compliance with US laws, have a wide selection of international stocks and mutual funds, and have a much lower fee structure and open reporting environment.  Unfortunately it can be difficult to open new accounts when not living in the US and some brokers prohibit mutual funds for people living outside of the US.  In this case, an alternative can be (Exchange Traded Funds (ETF's), which are similar to mutual funds, and I am not aware of any brokers who restrict purchases of ETF's, even for those living outside of the US.

Another option is using a US-based "discretionary" money manager (such as my wealth management firm, Maxim Global Wealth Advisors, www.maximadvisors.com).  The main restriction for selling US mutual funds to non-US residents has to do with the mutual fund companies not being allowed to solicit clients outside of the US (since they may then have issues with regulators in the foreign countries).  Using a discretionary advisor based in the US is acceptable for most mutual funds since the investment decisions are made in the US.

David Colvin is a CPA and CFP® based in Amsterdam, Netherlands since 1998. His niche focus is serving high-net-wealth individuals with cross-border tax and financial issues. He is also an advisor to Maxim Global Wealth Advisors, based in Amsterdam and Portland, Oregon.