Residential property as Property held for investment

San Jose, California
Tax, SDIRAs & Cost Segregation
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Residential property as Property held for investment

Max Voz
Member since 2023 · 1 post · 1 vote

Hello,

I reside in the Bay Area and currently, I do not own any domestic real estate properties. However, I have a home in a foreign country, for which I took out a loan to finance the purchase. If I categorize this property as a second home, the interest I've paid on the loan doesn't surpass the standard deduction. As of now, the property hasn't been rented out nor have I lived in it. If I were to rent it out, the cash flow would likely be negative.

Here's my query: Is there a possibility to classify the interest paid towards this foreign property as an "investment income expense", thus enabling me to subtract this interest expense from my capital gains? Considering my tax bracket is over 40%, this adjustment could potentially lead to significant savings.

I have found information online suggesting that interest expenses on properties held for investment can be deducted from capital gains, similarly to how margin interest is treated. Given that I neither rent out nor live in the property, can I designate it as solely held for investment purposes to benefit from this potential deduction?

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  • Noah Laker
    Real Estate Broker · Sacramento, CA · Member since 2021 · 517 posts · 408 votes
    3y

    Hey Max, it would probably be best to discuss this with a licensed CPA who understands the implications of international investment. I could recommend someone if you need help! 

    I'm an investor and broker up in Sacramento, I saved a fortune on taxes last year through Cost Segregation ("bonus depreciation") and STR business capex...

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  • Kevin Merck
    Accountant · Georgia, but Serve Clients throughout US · Member since 2023 · 5 posts · 0 votes
    3y

    Hey Max,

    I'm a CPA who specializes in real estate as well as in international taxation. This is not tax advice, but the short answer is yes, you can deduct the interest on the property as investment interest. It will be deductible to the extent you have investment income in the current year, and any excess deduction will roll over to the next year. But it needs to actually be an investment property, meaning that you are holding it with the intention of selling it for a gain. I hope that helps.

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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    3y

    @Max Voz

    "I have found information online" is solid. Can't beat that. :)

    If you're below the standard deduction, as you mentioned, trying to reclassify this interest as investment interest accomplishes nothing - even IF you can claim it as investment. Dead end.

    If you rent this property, then the interest can be deducted against the rent income. It will offset the extra income from rent but it will do absolutely nothing to offset your other income - which is what you're trying to do.

    Of course, this was a general answer based on the very limited information you shared.

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  • Simon Misiewicz
    Member since 2022 · 23 posts · 9 votes
    3y

    It sounds like you're exploring the possibility of treating the interest paid on the loan for your foreign property as an investment expense to potentially deduct it from capital gains. This strategy involves complex tax rules, and it's important to be aware of the potential implications:

    1. Deductibility of Interest Expense: Interest expense on loans for investment properties is generally deductible as an investment expense in the United States. However, whether you can apply this concept to a foreign property requires consideration of various factors, including the tax laws of both countries, the characterization of the property, and any relevant tax treaties.
    2. Investment Property Classification: To treat the property as held for investment purposes, it's generally important that your intention is to generate income or profit from the property, such as through renting it out. If you're not currently renting it out and don't have concrete plans to do so, it could be challenging to classify it as an investment property solely for the purpose of deducting the interest expense.
    3. Foreign Tax Implications: The foreign country in which you own the property may have its own tax rules regarding the classification of properties and the deductibility of interest. Additionally, the potential deduction of foreign property expenses against U.S. capital gains might depend on whether there is any dual taxation agreement between the U.S. and the foreign country.
    4. Documentation and Record Keeping: If you pursue this strategy, it's crucial to keep thorough and accurate records of your intentions, any rental activities, and the usage of the property. Documentation will be crucial in the event of any tax audits or inquiries.
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