This post appeared on the RenounceUScitizenship blog.
#americansabroad in Canada: The sale of your principal residence is a US taxable capital gain http://t.co/SQaSzY0Rgg
— U.S. Citizen Abroad (@USCitizenAbroad) July 12, 2013
If you sell a #PFIC (mutual fund) you have held for many years, you can"basically say goodbye to that investment" http://t.co/mu5k07xAv2
— U.S. Citizen Abroad (@USCitizenAbroad) July 11, 2013
For those who do not want to read this post. Here is the bottom line:
If you are a tax compliant U.S. citizen abroad, with a net worth of less than two million U.S. dollars, with investments (including mutual funds, pensions, and a principal residence in your country of residence), you should renounce your U.S. citizenship at the earliest possible moment. To the extent that your investments are in non-U.S. mutual funds, other kinds of PFICs or your principal residence, the U.S will confiscate large amounts of the proceeds of sale. (And you thought you were solving your problems be being tax compliant.)
Many Canadians are using their principal residence as their retirement plan. Their plan is to sell, downsize and live of the balance of the proceeds. This is NOT possible if you are a tax compliant U.S. citizen! You must NOT be a U.S. citizen at the time the investments are sold.
If you want to preserve your investments you must relinquish your U.S. citizenship to protect your access to your investments!
For those who want to understand why, read on …
Tax compliance and the U.S. citizen abroad
It has become clear for U.S. citizens abroad that the only thing worse than NOT being tax compliant is BEING tax compliant.
The cost of U.S. tax compliance is that your U.S. citizenship will disable you from effective financial and retirement planning. The reason is that the U.S. considers most non-U.S. investment vehicles to be PFICs. The sale of your principal residence will be subject to a capital gains tax. Furthermore, the additional “Obamacare taxes” imposed on investment income will make the situation worse.) The above tweet references a very good article explaining why, for U.S. citizens abroad, retirement planning is hazardous to your financial health.
The main point is this:
If you you own a principal residence or a non-U.S. mutual fund and you sell it (you will want to do this at some point) all the gains (and possibly more will be confiscated). Since some of you may think I am sounding “alarmist” I will quote from the above article by tax lawyer Virginia La Torre Jecker (yes, somebody else thinks so too):
Don’t Mind Losing Your Investment ? PFIC Means Very Harsh Tax Consequences
The harsh bite of the PFIC tax rules will make itself known in either of two events: 1) when the fund makes a distribution (called an “excess distribution”) to the investor or, 2) when the investor disposes of his PFIC shares (a “disposition” of PFIC shares can occur by redeeming them, selling them, gifting them away, or even by giving up one’s US resident status or citizenship). When taxation occurs, the amounts will be taxed at the highest ordinary income tax rate for the investor without regard to other income or expenses (currently the highest individual rate is 39.6% plus, don’t forget the 3.8% Medicaid Surcharge). Long-term capital gains treatment does NOT apply.
To add insult to injury, the amounts on which the PFIC tax is to be calculated are “thrown back” evenly over each of the tax years that the investor held his shares. Tax is then assessed for each prior year at the highest possible tax rate that was in effect at such time. Then, interest is compounded on the deferred tax deemed due for each year. These high rates can very easily eat up the investment by removing the benefit of any tax deferral. If an investor has held his PFIC shares for many years, he can basically say goodbye to that investment. By way of example, assume Taxpayer redeems his PFIC shares at a gain of $10,000 in 2013. Assume he held the shares commencing 2009. In this case, $2,000 of gain will be deemed to have been earned in each of the five years 2009 through 2013. Tax will be assessed at the highest possible tax rate for each year and compounded interest will apply on the taxes due. Various tax elections can possibly be made to avoid this harsh treatment. Making an election, however, is not always a simple matter since certain requirements must be satisfied. Many times, the requirements cannot be met and the taxpayer is left in the lurch.
What does this mean practically?
It means that you may have to renounce your U.S. citizenship in order to save your financial future. This is why the issue of being a “covered expat” is becoming more and more important. If you are NOT a covered expat, you will get your “Get of Jail Free Card” for free. You are NOT subject to the mark to mark exit tax rules. If you are a “covered expat” there will be a deemed sale of your mutual funds (and all the horror that this sale implies). You cannot afford to be U.S. citizen when you sell your investments.
U.S. citizens abroad who:
1. are tax compliant
2. have investments they do not want confiscated by the U.S. government
3. have a net worth of less than two million
4. are not paying more than about 150,000 per year in taxes should:
Renounce your U.S. citizenship now!
It’s necessary to preserve your financial future. If you continue your habit of “tax compliance” (playing by the rules) and you reach the two million mark which is inevitable, you will be locked in a fiscal prison the rest of your life!
Caveat: Those who were born dual citizens and meet other requirements may “Get out of jail free” in any event.
Epilogue – Added one day later …
An interesting discussion which touched on the issue of non-U.S. mutual funds has been taking place at the Isaac Brock Society. See this thread.
Note this comment in particular. Note specifically the words I have bolded. Do NOT see these investments until you are no longer a U.S. person!
@Neill
Ignore this if you plan to reside in the US permanently. Also, I have no idea whether this option would still be available to you if you have already filed returns using the MTM method for PFICs.
Have you examined reporting your PFICs under the excess distribution method? Under this method, you pay tax only on the dividends distributed by the underlying PFICs. Most of the dividends will be treated as ordinary dividends in the year the dividend was received. Dividend distributions in excess of 125% of the three year average are deemed excess distributions and the excess portion as apportioned over the holding period and taxed at the highest marginal rate in the period plus interest. However, it avoids having to pay “capital gains” tax on a MTM basis which is where you can get whacked by dollar depreciation or underlying fund appreciation or both. If the underlying funds you held paid a fairly stable rate of dividends from year to year then most of the dividends will be treated as ordinary dividends.
Additionally, I’ve had two different sets of tax preparers tell me that only dividends from Income class shares need to be reported as dividends since Accumulation class shares don’t distribute dividends.
If you bought and held your PFICs, if you have PFICs that are Accumulation class shares, and if you don’t plan to permanently reside in the US, and if it is possible to amend the returns submitted, it may be worth investigating. This method, however, produces absolutely brutal consequences if you sell the holding while you are US tax resident.
(In context the words “while you are a US tax resident” actually mean “while you are a US person”.)
This is the AWARENESS that the US has not provided. It is provided by USCitizenAbroad and others here at Isaac Brock and other sites like Maple Sandbox. Are we a mere voice in the wilderness?
When I think of how lucky I am (at a great cost paid from my retirement savings) to be out from under this with my Net Worth figured at under $2 million, a figure that is quite arbitrary considering if my inflated house and its value were situated in Oklahoma or somewhere else in this big wide world instead of Calgary, Alberta, Canada, along with the Present Value of my employer defined benefit pension (as if I had collected my pension for twenty years out). It is nothing but luck that I am out of this (and because I could NOT have done it by myself, with the help of US tax and accounting professionals — for my peace of mind, it is money well spent, but should I have had to spend one penny of my 100% earned Canadian retirement savings on this? That I had to do that, I resent. That I had the retirement savings to be able to do that, I am thankful — so very many do not!), with I hope no repercussions, except what could ensue with my son’s entrapment into US Citizenship — which I will not submit to. I am someone who has diligently saved from the profession of “administrative assistant,” taken advantage of Canadian registered accounts in saving for the future for me and, as much as I can, my family. As a single parent I had that not wanting to be a “bag lady” mentality spurring me on.
When I think of my stupidity, my unawareness of, complacency in living my life as “only a Canadian,” since my Canadian citizenship in 1975,
When I see no heed by the IRS paid to educating persons abroad, http://isaacbrocksociety.ca/2013/07/11/taxpayer-advocate-continues-criticism-of-irs-execution-of-voluntary-disclosure-programs/comment-page-1/#comment-430047
When I continue to see the great benefits and entitlements of US citizenship expounded to US children, as void as it is of also giving them the knowledge of what US citizenship-based taxation responsibilities / consequences are, http://isaacbrocksociety.ca/2013/07/08/article-implies-born-abroad-to-us-citizen-parent-not-automatically-us-citizen/comment-page-1/#comment-425416
When I see no efforts either by the US or other countries who will employ workers from the US on what the consequences of US citizenship-based taxation to those (exploited) workers are,
When I realize the entrapment of the “mentally incapacitated” into US citizenship with no way out unless they, too, heed USCitizenshipAbroad advice to place the onus on the US / IRS to prove they are citizens to be robbed of the little they have,
When I see heads buried in the sand, thinking this won’t affect them,
I am incensed and at times sleepless. I am working on that in my own ways. What is going on is another example of ‘blaming the victims.’
Can we educate enough people in our own countries, let alone those in the homeland, that they must always pay attention?
We are not as entitled or blessed by some God as we may think. It’s all unsustainable. The US is doing its best to remain top dog in the survival of the fittest. Duped victims be damned.
@USCitizenAbroad,
Several US tax attorneys have advised some of my IRS compliant colleagues that non-US mutual funds are not PFICs because final IRS regulations have not yet been established–and that one presently has a “defensible” position in claiming that these mutual funds are not PFICs.
Maybe so, but I feel that this is bad advice and is taking a huge risk as IRS can go retroactive. These funds, like us, are toxic and should never be owned. (Even if I would wish to pay US tax on the mutual funds, I would never be able to figure out how to fill out even one of the forms and I refuse to pay a tax professional to do so.)
I recall that at the Toronto IBS meeting it was mentioned that we have this non-US mutual fund-PFIC mess because of the US mutual fund lobby in congress.
Regarding capital gains on principal residence, consider gifting US person portion of house to non-US spouse, if possible in your country, to avoid IRS capital gains tax or to get under $2 million covered status if necessary.
All this is nonsense.
This has become a very sticky issue in our home. We live in a highly desirable neighbourhood. We bought an estate sale to be able to move in here, otherwise we could not have afforded it. The idea was to fix up this place *we have* and then sell and move out to downsize just as you have stated in the article. The property taxes in my neighbourhood are some of the highest in this province. They are higher than our mortgage now and going up every year. So, we were all set to get ready to sell when all this U.S. person thing came up and FBAR and all the rest. My spouse wants to sell asap and so do I but, I need to ditch being a U.S. person first. Spouse is NOT giving the U.S. a dime of our hard earned money on this house. He has killed himself getting it fixed up and it’s very nice now. In a neighbourhood where ups and downs in the market have not affected a thing to do with sale prices, ever. Everyone who moves to this city wants this area. Best schools, best location and quite small so hard to get into when you do move here. We should be all set. But no, we’ve had to wait and keep paying higher tax than we can afford now until I’m renounced.
This mess has caused each and every family going through it such angst and so much money. It would be funny were it not so horrible to deal with. After all I owed them no taxes! But here we sit until I can renounce. I resent this like hell as we should have had our house on the market last year!
I’m glad you wrote this article because it was a long time before I even knew that the U.S. would take part of the cg if we sold! Nobody told us, I found out literally by accident. Where is the U.S. responsibility in letting us know these things!?! We were within a hairs breath of having a sign in our yard when I found out about this. This has affected my marriage at times as it’s a daunting task to tell someone “Oh, we can’t sell yet…I”m sorry.” It is shocking that being a U.S. citizen makes us such a pain to our families. What’s even more disconcerting is that the press in the U.S. on this is still all about the uber wealthy off shoring tax “cheats” with zero information about the actual outcomes and impacts on average U.S. persons and our families abroad included. They have to know yet the WH approved articles keep coming. Truly distasteful to even read any of that since it is so obviously propaganda.
Some stuff on PFIC.
For immigrants there are various rules for when the mutual fund becomes a PFIC. It only does so when you land in the US (or dive down from Canada or up from Mexico and arrive at your destination, yes they have rules like this). My lawyer appeared ignorant of this and I found it out by reading the “CODE”. This lets you project back the earnings only over the years you were a US person. If you could do retro-active MTM elections then there is actually two basis for the PFIC. You get capital gains treatment for the gains before getting US leprosy. Now most doc suggest you can’t retro-actively file for MTM but I found this post that suggests there is a IRS statement somewhere that says you can:
http://www.taxalmanac.org/index.php/Discussion:Cost_Basis_of_PFIC_Stock_After_Becoming_a_US_Resident
I was unable to locate anything in the IRS though.
In my case it’s very clear that when my wife saw the CPA’s in the US and disclosed her foreign mutual funds they should have told her she really had no option but to sell them in the first year or waste the money. They told her nothing. Not even that the ISA’s were taxable in the US. Arthur Andersen did go belly up which makes me feel a little better.
For the immigrant the PFIC rules have some interesting funnies. Foreign mutual funds are not actually PFICs until you enter the US. They even include driving time to your work if you enter from Canada and Mexico.
What this means is when you do the default PFIC calc you only project the earnings over the time you were a US person and not the time you held the shares.
Now if you elected MTM calculations you get two basis in the PFIC stock. Capital gains for the time before you got US leprosy and PFIC for the after times!
Most IRS doc suggests you can’t retro actively file for MTM but I did find one practitioner saying these is a statement by the IRS that you can:
http://www.taxalmanac.org/index.php/Discussion:Cost_Basis_of_PFIC_Stock_After_Becoming_a_US_Resident
I have been unable to find this though. It would likely be very useful to people if it exists. A question then arises. Can you use the split basis in the modified MTM offered in the OVDI/P? My lawyer thinks no.
Damn. I ended up with two comments after the first one disappeared into a black hole.
Neill, I don’t know where they would have gone. They didn’t show up in “spam” for this site.
(I often type my comment into Word and it stays there OK. When I am ready to put it on, I copy and paste into an Isaac Brock comment.)
My first comment disappeared for ages. So I retyped. Then both showed up!
Neill,
Full disclosure of the products we invest in is important.
eg. the Canadian registered accounts, TFSA, RESP, RDSP that we are “encouraged” to save with do not come with a Warning — reconsider this investment choice if you are a US Person — for you, it is a toxic investment (but not for any other Canadian wherever they may have come from originally or who they were born to).”
@Neill
Maybe I misread your post. Are you saying that the US taxes the unrealised capital gains you achieved prior to becoming a US tax resident?
@Edelweiss
No they don’t tax the unrealized gains. When you come to sell the gains before the mutual funds becoming PFIC’s are taxed as capital gains and the basis is stepped up for the PFIC rules to apply. Check for something called the transition rule in the code.
One interesting thing about the exit tax is that it would tax a green card holders foreign pensions before a distribution. This is in violation of the tax treaty (certainly the UK one) but they have this language in all of them.
Even for a US citizen renouncing the savings clause that takes away options for a US citizen don’t extent to deferred growth of foreign pensions. The US only gets to tax it on distributions. So I think it’s a violation of the tax treaty in that case as well.
Even foreign money market funds are considered PFICs.
One more twist on PFIC is that each lot (with a different buy date or sale date) of shares is treated separately. All the lots on which there is a gain are subject to the tax treatment that’s been described, but any lots with losses are treated as capital losses (either long term or short term) which can be used to offset other capital gains but NOT PFIC gains.
My understanding of US tax law is that gain on the sale of a principal residence is treated the same way regardless of whether the residence is located in the US or outside the US. Anyone know for sure?
@Neill,
I saw your first comment in the Spam filter (that happens occasionally for no apparent reason) at 12.19 and moved it here (I’m one of the administrators). I see that your second comment is worded a bit differently. So, I’ll leave them both up. If you’d like me to take one down, though, just let me know.
@Edelweiss, not unrealized gains, but the US will tax realized gains where some, perhaps all, of the gain came from before moving to the US. It will also tax currency gain that occurred before moving to the US:
http://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/us-tax-foreign-citizens-2012.pdf
“Sale of Other Capital Assets
…If property was acquired before you became a U.S. resident, you must still use the original cost, which effectively means that you will be taxed on appreciation of the asset that happened before you became a resident.”
@Neill, the US claims that HEART does not override the treaty because it taxes you on a distribution deemed to have been made on the day before you leave. This is of course just weaselling. It is definitely a treaty override. Two legal fictions to try to justify an unjustifiable position. I have complained several times to my UK MP and UK treasury about this one-sided treaty issue, and the fact that the US repeatedly reneges on treaty commitments. So far they appear uninterested. For the moment I have given up in disgust.
Ah, ok. I misunderstood.
Woo! I sent off my 2012 1040 today. Total damage – tax adviser about $1,700 (mainly because of 8 x 8621 forms), US tax liability ($1), at least 100 hours of my time, ~105 pages. What a monumental waste.
@Watcher,
Nice. Force you to do a taxable event to bypass the need for you to do a taxable event to tax you. That can’t be right.
@Edelweiss,
My US tax return this year was 150 pages. Thank god I don’t have to do one for the UK. I feel your pain. That sucks.
One thing to note about the modified MTM calc allowed in the OVDI/P. It sounds like a deal because the tax rate is 20% but it may not save you that much. This is because the gains and penalties on gains are projected though years were you didn’t own money. For example say in 2004 you made $1000 on an investment. It may not have really made that much but the $ could have declined.
So they apply the accuracy penalty to that and then apply interest to them both from 2004 to the present day.
Now lets say you lost $999 in 2005. That will just subtract that loss from your total tax bill. No projecting that loss or negative penalties. No offset to the interest they claim you owe them even thought the next year they owed you.
So you can see from this that market fluctuations can generate large gains and penalties and interest even though you made little money. 2004 to the present day contains a huge run up and a big drop to set us all up for this.
@Edelweiss: ~105 pages. What a monumental waste.
Not a complete waste, since this will gum up the works at the IRS a little. Hopefully you sent it on paper. For extra points, you can transcribe part or all of it onto handwritten (captcha-quality) forms to force the IRS to enter it manually. I do that. I also request paper copies of forms to be sent to me, then photocopy some onto A4 so the IRS receives a mix of A4 and letter. I then fold aggressively into a small A4 envelope, so that the final sheaf of stuff will not sit tidily on a shelf or desk or in a file. Finally, I mail everything recorded delivery to the IRS in London, so that they have the job of shipping it onward to the US.
These are the small rebellions that help to keep me sane.
@Watcher
I do admire your creativity. I think my 8854 next year will look fetching in purple crayon with a side of prominent coffee smudge.
I most certainly did send it on paper together with Form 8948 (Preparer Explanation for Not Filing Electronically). 400g of A4. It’s a shame my printer was running a bit low on black ink.
Calgary411 –
When I see heads buried in the sand …
OSTRICH HEADS !!!
usxcanada,
Yes, US Person Ostrich Heads.
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@watcher
Legal sabotage, I like it.
@Calgary
Getting more surreal every day. With today’s announced FATCA extension: “A jurisdiction may be removed from the list of jurisdictions that are treated as having an IGA in effect if the jurisdiction fails to perform the steps necessary to bring the IGA into force within a reasonable period of time.” I cannot fathom how any country can put their faith in something as subjective as that, especially when the US grows more desperate every day. This is complete insanity, but as long as no nation is willing to put the brakes on this, the FATCA train will continue to hurtle along full speed destined to crash and burn on the innocent.