1031 Exchanges enable Exchangers to defer Capital Gains taxes by reinvesting the proceeds from selling an investment or business use property into another. It’s important to understand the distinct rules for domestic and foreign properties: you can exchange a U.S. property for another U.S. property or a foreign property for another foreign property, but you cannot exchange a U.S. property for a foreign property, or visa versa. Exchangers should carefully plan and educate themselves on the rules and regulations of 1031 Exchanges to ensure they will retain tax deferral benefits.
Do US Taxes Apply to Foreign Real Estate?
Prior to discussing the considerations for 1031 Exchanges involving foreign property, it is important to understand how United States taxes apply to foreign property. If a US taxpayer, or taxpaying entity, owes property outside of the United States, the property or income generated from the property is treated largely the same as domestic property, including:
Profits from the sale of property for a profit those proceeds would be subject to taxation
Income generated from the ownership or operation of foreign real estate is taxable income
Property owners can deduct qualifying expenses for foreign properties to lower their taxable income
Property is eligible for depreciation, although foreign commercial property is depreciated over 40 years and foreign residential property is depreciated over 30 years, versus the 39 years and 27.5 years respectively for domestic properties
In summary, foreign property owned by a taxpaying citizen of the United States is essentially treated the same as domestic property in regard to annual taxes.
Do 1031 Exchanges Apply to Property Outside the United States?
In a 1031 Exchange, both the Relinquished and Replacement Properties must be like-kind.