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Good morning. My wife and I are Australian expats living the the US since 2013. We have our family home still in Australia which we are renting out while abroad. We are reporting the income on this property on both AUS and US tax returns (getting foreign tax credit).

This year our tax accountant has advised that because we paid down some of our AUD home mortgage during the year, the IRS is entitled to tax us on the FX gain (between taking out the mortgage in 2011 and today) on the movement on our mortgage balance. As any Australian knows the AUD to USD have moved considerable over this time.

Note we have not sold the property, nor refinanced or extinguished the mortgage just paid down the balance by $100k.

Has anyone had similar experience and is this the correct treatment? I have been unable to find any solid tax ruling on this. Its being included on Form 8949 of the IRS return.

Thanks for the support. Sounds like it's still a grey area. To answer some of the questions:

Part of the funds came from a transfer of USD to AUD during the year but the rest came purely from the payment of the mortgage using funds received from the tenant. The monthly mortgage repayments were interest plus principal.

When I spoke to the accountant (Big 4), I asked him if I had have left the mortgage balance the same and but the excess funds in a term deposit or such would this be an issue and he said no. All I would be liable for would be the tax in term deposit earnings!! Just crazy

Also just to clarify, the property was not and will not be sold while we are living in the US.

DJohnM - I had seen this article but per someone else's comment, had assumed it related to sale of asset not just mortgage movements over course of loan.

I'm seeking additional advice this week.

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    They don't tax a US citizen when you pay down their mortgage. Could it actually be because of where the money came from? Did you cash out an investment / retirement account, inherit money, gift from in-laws?
    – mkennedy
    Apr 18, 2016 at 19:30
  • @mkennedy I think the issue is that this mortgage is denominated in a non-USD currency.
    – Patricia Shanahan
    Apr 19, 2016 at 9:59
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    Ask the accountant why he hasn't been reporting the draw down of the mortgage that's occurred each year as you paid principal (in your monthly payments) and the AUS$ has dropped against the US$.
    – mkennedy
    Apr 19, 2016 at 13:29

2 Answers 2

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Has anyone had similar experience and is this the correct treatment? I have been unable to find any solid tax ruling on this. Its being included on Form 8949 of the IRS return.

I don't think this is correct treatment. You should get a statement from the bank servicing your loan as to how much interest you paid during the year, and you get to deduct that interest (after currency conversion) on your Schedule E from the rental income.

If you didn't sell the house, then why would you be filing the form 8949? And why would a change in your US$ value of the loan be of any of the IRS business? I don't know why the accountant would say that, and from the facts you've mentioned in the question - it doesn't sound right. I suggest asking for clarifications.

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Look at it his way: in 2011 you borrowed some AUD and bought the house. You've paid interest on the loan, and accounted for it in your taxes as a cost against the rental income.

You've also paid back some principal, and the AUD/USD exchange rate has changed.

Suppose you borrowed 1 000 000 AUD at a time when the exchange rate was 1 to 1. So the IRS sees a debt of 1 000 000 USD.

You start to pay back principal, as the AUD tanks. Suppose you pay back 400 000 AUD, with an average exchange rate over the payments of 1 AUD = 0.75 USD, and at that point, the exchange rate has dropped to 1 AUD = 0.5 USD

From the point of view of the Australians, you now owe 600 000 AUD.

From the point of view of the IRS, you borrowed 1 000 000 USD, paid back 300 000 USD (0.75 times 400 000), and now owe 300 000 USD (0.5 times 600 000). 400 000 USD appeared out of nowhere, and the IRS wants their share...

See this site https://renounceuscitizenship.wordpress.com/2012/10/11/how-fluctuating-fx-rates-generate-capital-gains-taxes-on-the-discharge-of-debt-us-citizens-abroad/ for more horrible details...

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    From what I can tell, that site is talking about a payoff of the loan/sale of a capital asset. Neither of which the OP has done. If this FX gain was true, they should have reporting the "income" each year that rate has changed--because each month they pay down the principal. It shouldn't matter if it was the monthly payment or a lump sum payment--doesn't matter until they sell the house.
    – mkennedy
    Apr 19, 2016 at 13:27
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    The extra $400K didn't appear out of nowhere. It's **equity**, and equity is not a taxable income. If you buy a house in the US for $500K, but in 5 years it is valued at $1M - do you pay taxes on the extra $500K that appeared out of nowhere? No. There's no difference here. When the house is sold and that equity is realized, the OP will be taxed on the US$ income even if he sold at a loss in AU$, that's what that site is talking about.
    – littleadv
    Apr 19, 2016 at 15:43
  • @litleadv Is your answer to my question here, money.stackexchange.com/questions/43254/… relevant?
    – DJohnM
    Apr 19, 2016 at 17:25
  • @DJohnM not really, since in that case you're the note holder and get money for note redemption. You were in fact disposing of a capital asset. That's not the scenario the OP was describing.
    – littleadv
    Apr 20, 2016 at 5:26
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    The article you linked also talks about discharging of debt, but I'm not sure there's any justification for that hypothesis. Original loan is $100K AU$, ending balance is 0 AU$, there's no debt discharged. While there's a lot of things to say about the US tax code and especially it's punishment of expats, this specific example seems to be not really correct. Also, you can select AU$ as functional currency for your Australian rental, but you have to do it from the first year.
    – littleadv
    Apr 20, 2016 at 5:34

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