Moving abroad can open the door to new financial opportunities. U.S. expats may invest in local stocks, mutual funds, exchange-traded funds, property, retirement accounts, or other financial products in their country of residence. However, owning investments outside the United States can also create additional U.S. tax considerations.
One of the most important things for American expats to understand is that moving overseas generally does not end their U.S. tax obligations. U.S. citizens and resident aliens are generally subject to U.S. tax on worldwide income, including income and gains from investments held abroad.
The following are some of the most common issues expats should consider when managing foreign investments.
Foreign investment income still needs to be reported
A common misconception is that income earned outside the United States does not need to be included on a U.S. tax return.
For U.S. citizens and resident aliens, that generally isn’t the case. Foreign-source investment income, such as dividends, interest, and capital gains, may need to be reported on the U.S. tax return even when the income is held in a foreign account and even if no U.S. financial institution issues a Form 1099.
This means an American living in the United Kingdom, Australia, Canada, France, or another country may still need to report income generated by investments held in that country.
Keeping accurate records is particularly important when investments are denominated in a foreign currency. The U.S. tax calculation generally needs to be made in U.S. dollars, meaning exchange rates can affect the reported value of transactions.
Capital gains can become complicated
Selling a foreign investment for more than its adjusted cost basis can create a taxable capital gain for U.S. tax purposes.
For example, an expat might purchase shares of a foreign company for the equivalent of $10,000 and later sell them for $15,000. The resulting gain may need to be reported on the U.S. tax return.
However, the calculation can become more complicated when the investment is denominated in a foreign currency. The U.S. tax system generally measures the purchase and sale transactions in U.S. dollars, so currency fluctuations can affect the U.S. dollar gain or loss.
Understanding US Capital Gains Tax is therefore important for expats who sell foreign investments.
The tax rate may depend on factors such as the type of asset, how long it was held, and the taxpayer’s overall taxable income. Different rules may also apply to particular types of foreign investments.
Foreign mutual funds and ETFs can trigger PFIC rules
One of the most significant issues for expats is investing in foreign mutual funds or ETFs.
A foreign investment company may be classified as a Passive Foreign Investment Company, or PFIC, under U.S. tax rules. When this happens, special reporting and taxation rules can apply.
U.S. taxpayers who own PFICs may have a Form 8621 filing obligation in certain circumstances. The IRS specifically notes that a U.S. person who owns a mutual fund or ETF that is not domiciled in the United States may have a Form 8621 obligation.
PFIC taxation can be considerably more complicated than the normal taxation of stocks and may create unfavorable tax consequences depending on the circumstances.
For this reason, expats should not assume that a locally popular investment fund is automatically tax-efficient from a U.S. perspective.
Foreign accounts may create additional reporting requirements
Owning investments through foreign financial accounts can create reporting obligations separate from the income tax calculation.
For example, some U.S. persons with foreign financial accounts may need to file a Report of Foreign Bank and Financial Accounts, commonly known as the FBAR, when the applicable reporting requirements are met.
Form 8938 can also apply to certain specified foreign financial assets when their total value exceeds applicable thresholds. Importantly, Form 8938 and the FBAR are separate reporting requirements, and filing one does not automatically satisfy the other.
This distinction is easy to overlook when an expat has multiple accounts spread across different financial institutions.
Foreign taxes do not necessarily mean you pay tax twice
Another concern for expats is double taxation.
An investment may be taxed both in the country where the taxpayer lives and under U.S. tax rules. Fortunately, U.S. taxpayers may in some circumstances be able to claim a foreign tax credit for qualifying foreign income taxes paid or accrued on foreign-source income.
The foreign tax credit can help reduce U.S. tax liability when the same income is subject to qualifying foreign income tax. However, the rules governing the credit can be complex, and not every foreign tax qualifies.
Tax treaties may also affect how particular types of income are treated.
This means expats should consider the interaction between their country’s tax system and U.S. rules rather than looking at either system in isolation.
The Foreign Earned Income Exclusion does not cover investment income
Some expats assume that using the Foreign Earned Income Exclusion means their foreign investment income is also excluded from U.S. tax.
Generally, the FEIE applies to qualifying foreign earned income, such as wages and self-employment income. Investment income is not foreign earned income. The IRS specifically distinguishes investment income from income earned through personal services.
As a result, an expat may use the FEIE for qualifying employment income while still needing to report dividends, interest, and capital gains from foreign investments.
This distinction is especially important when creating an overall tax strategy.
Currency movements can affect investment calculations
Currency exchange rates can create another layer of complexity.
An investment may increase in value in its local currency but produce a different result when converted into U.S. dollars. Likewise, a foreign account’s balance may change because of both investment performance and movements in the exchange rate.
Expats should therefore maintain records of purchase dates, sale dates, transaction amounts, and the relevant currency values.
The same issue can arise when determining whether foreign financial assets exceed reporting thresholds. IRS guidance for Form 8938 requires foreign-currency amounts to be converted into U.S. dollars using applicable exchange rates.
Good recordkeeping can prevent problems
Foreign investment reporting becomes much easier when records are maintained throughout the year.
Expats should consider keeping:
- Brokerage statements
- Purchase and sale confirmations
- Dividend and interest statements
- Records of foreign taxes paid
- Investment cost basis information
- Foreign currency exchange information
- Account statements showing maximum balances
Waiting until tax season to reconstruct several years of investment activity can make an already complicated return much harder to prepare accurately.
Final thoughts
Investing abroad can be an important part of building financial security while living outside the United States. However, U.S. expats need to remember that foreign investments generally remain within the scope of U.S. tax and reporting rules.
Capital gains, dividends, foreign mutual funds, currency fluctuations, foreign taxes, and financial account reporting can all create different considerations. The fact that an investment is legal and common in an expat’s country of residence does not necessarily mean it receives the same treatment under U.S. tax law.
By understanding these potential issues and keeping detailed investment records, Americans abroad can reduce the risk of unexpected tax problems and make more informed decisions about their international investments.
