How to pay foreign rentals

Mansion Global poses a tax question to real estate tax attorneys every week. Here is this week s question.

Q. I live in New York and have rental properties in London. Do you owe U.S. taxes on foreign rentals?

A. U.S. citizens and residents are required to report all their income for taxation, which means income earned abroad, like foreign rentals, sales of properties and distributions received from the property are subject to being taxed, said Mike Kosnitzky, a partner at Pillsbury Winthrop Shaw Pittman in New York.

If someone mainly lives in New York but has rental properties in London, they owe U.K. taxes not to mention state tax on top of U.S. federal taxes, but the U.K. has a treaty with the U.K. that allows residents to avoid paying taxes twice, said Kosnitzky, who co-leads his firm's private wealth practice.

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He said that you need to structure things properly in order to make sure that you don't double pay, in order to take advantage of the foreign tax credit for taxes in the U.K.

Most high-net worth individuals don't own real estate directly but through a type of company such as an LLC that works best for their particular circumstances. U.K. corporations are subject to a lower tax rate than individuals - 19% for corporations compared to a maximum of 45% for individuals - which is creditable in the U.S.

There are other taxes to take into account. If there are mortgages on the property, there are special U.S. tax rules that come into play when the property is sold if the debt is denominated in foreign currency, called a foreign mortgage gain.

"Any foreign currency transaction is treated as if you traded a currency," Kosnitzky said. That is usually a little quirk. In the U.K. there is a stamp duty land tax, which is a progressive tax on the purchase of U.K. properties. There is no such tax on properties less than 125,000 and reaches a maximum of 12% for properties 1.5 million and over.

The tax has its own wrinkle for U.S. residents.

It is not based on income, so you don't get a foreign tax credit for that, according to Kosnitzky.