When owning UK property, there are a number of considerations and taxes to bear in mind in order to ensure that you are not caught out in the long run, but as ever the complex world of being an American abroad can be negotiated with relative simplicity with the help of a little planning.
To highlight how these rules can be easily overcome, we’ve shared Shirley’s story who moved to the UK and bought a house with her husband. As a Buzzacott client, our advice helped Shirley benefit from:
- Saving a potential US Income Tax bill of $50,000
- Saving a potential US Income Tax tax bill of $7,377 upon re-mortgaging her home
- Saving $1900 on her Net Investment Income Tax
Case study: How to reduce the US tax bill on UK property
Shirley moved to the UK in the mid 90’s and not long after, Shirley and her non-American husband bought their first home together. Now with a growing family they want to move to a larger home but find themselves faced with a potentially unmanageable US tax bill on Shirley’s portion of the property. Here is how our Expatriate Tax Services team helped Shirley and her family reduce their global tax exposure when they decided to move house.
As is the case with many married couples, Shirley and her husband held their home under a joint tenancy. This means that as an American, Shirley would be taxable in the US on 50% of the overall increase to the value of her home. She also has a UK mortgage, something for which the US has some rather unusual rules.
Capital Gains Tax: US v UK
On the US side, as Shirley has owned her home and used it as her main residence for at least two years out of the five-year period ending on the date of sale, Shirley can claim a capital gain exclusion in the US of up to $250,000. Any additional taxable gain is then taxed at a rate of 20%. By contrast, in the UK Shirley and her husband can claim the UK property as their Principal Private Residence (PPR) as they lived in the property from the date of purchase to the date of sale. Therefore, the entire gain arising from the sale is exempt from UK Capital Gains Tax, leaving Shirley with a potential US tax bill of $50,000 on her anticipated gain of $500,000.
Foreign mortgage gain
Having taken out a joint mortgage with her husband to purchase their home, Shirley must also deal with the US tax rules governing mortgage debt denominated in foreign (non-US) currencies when she sells her home. Under US rules, Shirley is deemed to transact in US dollars, consequently, any foreign currency transaction is always deemed a ‘trade’ for US purposes. In other words, paying off her UK mortgage could trigger a gain or loss when the mortgage is relinquished. Shirley and her husband re-mortgaged in 2012, and unfortunately, since then the US Dollar has risen against the pound, leaving her with an exchange rate gain of $36,833 on the relinquishment of her mortgage. This may result in a potential tax bill of $7,377. Fortunately for Shirley, she had enough excess tax credits to offset this on her return and reduce the liability to nil.
Net Investment Income Tax (NIIT)
This is an additional tax of 3.8% imposed on investment income and capital gains where the taxpayer’s income is over certain thresholds. For Shirley, who files as ‘Head of Household’, she will suffer this tax on all her gains over a modified adjusted grow income threshold of $200,000, which initially would have left her with an additional tax bill of $3,302
All in all, Shirley’s US tax bill was expected to be $53,302.
Stamp Duty Land Tax (SDLT)
SDLT is a progressive tax levied on the purchase of UK (excluding Scotland) properties on a sliding scale system starting at 0% with a purchase price of up to £125,000, up to 12% on property values over £1.5m (Scotland has a similar Land & Buildings Transaction Tax). Once paid, the SDLT is added to the cost basis of the property to reduce the eventual gain upon disposal. In addition to her joint property in the UK, Shirley inherited a property in the US from her mother in the early 2000’s. As of 1 April 2016, an additional 3% SDLT will be charged on the purchase of a UK property if at the end of the day a person owns two or more residential properties. This means that because of Shirley’s old family home in the US she will face an additional 3% SDLT on the purchase of her new home in the UK.
Capital Gains Tax
Since Shirley is taxable in the US on 50% of the gain over $250,000, the best solution was to decrease Shirley’s holding in their UK property ahead of it being sold. Following our advice Shirley and her husband changed their ownership from joint tenants to tenants in common. By utilising the US annual gift allowance of $155,000 per year, and the lifetime gift allowance of $11,40,000 Shirley was able to reduce her holding in the property down to 25%. This left her with a US taxable gain of $250,000, which was covered by the US exemption. Great news for Shirley as it removed both her US Capital Gains Tax and liability entirely, and reduced her NIIT down to a more manageable $1,402.
Our advice helped Shirley save $51,900 on her US tax bill, now just $1,402.
Stamp Duty Land Tax (SDLT)
When transferring property in this manner it is important to check whether there was any consideration received on the transfer for SDLT purposes. HMRC charge SDLT on the amount of consideration given in exchange for the property, in Shirley’s case her husband has taken on an additional 25% of the mortgage in exchange for an additional 25% of the property. If that portion of Shirley’s mortgage were over the SDLT threshold of £125,000 then they would owe SDLT on the exchange. As the mortgage is low enough however, this will not be an issue here.
Shirley has a buyer lined up for her house in the US and because it will be completed within 3 years of her UK house purchase, she can apply for a refund on the additional 3% SDLT.
Another important aspect of a transaction like this is legal advice as wills may need to be updated and a conveyancing solicitor is needed to prepare the transfer documents.
Shirley has benefited from going to one firm to receive joined up tax (US and UK) and financial advice. Buzzacott’s Expatriate Tax team have become market leaders in helping American individuals in the UK with both US/UK tax advice and compliance services.
The full Stepping Stones series can be found here.
Buzzacott's specialist teams can help.
If you would like to speak to one of our expat tax specialists, please fill out the form below and we will be in touch shortly.