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Whether you invest money in Des Moines or Dar es Salaam, the IRS expects its cut. If you invest in real estate overseas, any income you get from the property -- adjusted for the current exchange rate -- is taxable. You can claim legitimate deductions for real estate abroad, just as you can for real estate at home.
If you invest in, say, a rental house in Provence or Cornwall, the same rules apply as for a house down the street. You can take off mortgage interest, both the portion of interest you make in your monthly payment as well as any points -- pre-paid interest -- you paid at closing. Repairs and maintenance are deductible, and you also get to write off depreciation for wear and tear on any buildings you've invested in. You can take off foreign property taxes too.
If you own, say, a Mexican property and pay tax on your investment income to the Mexican government, American law usually protects you against paying twice. Instead, you take the value of your foreign income tax and claim it as either an itemized deduction on Schedule A or as a tax credit. If you take a credit, you base it on either the foreign or U.S. tax on the foreign income, whichever is smaller. You can't write off foreign property taxes, just income tax.
If you have a vacation home that you rent out most of the time, you have to split your mortgage-interest deduction. Say you rent out your Roman villa nine months of the year and vacation there the rest. You can only claim 75 percent of the mortgage interest as a rental expense. You can take the other 25 percent as a personal write-off on Schedule A, provided the house qualifies.If you already deduct mortgage interest on two other personal homes, for instance, you can't deduct interest from a third home.
You report income and expenses on the same forms you'd use for American real estate. If you take the foreign-income tax credit, you add Form 1116, unless your income is "passive," such as money from a rental. In that case, you can take the credit without the paperwork. If you're actively involved in managing rental property overseas, you can deduct up to $25,000 in losses. Otherwise you carry losses forward to next year.
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