Last week we began the story of John and Jane Farkle, U.S. citizens who had decided to expatriate (i.e., renounce their U.S. citizenship) after becoming disillusioned with the U.S. political climate. Unfortunately, the more they learned about the expatriation process and the tax implications, the more disillusioned they became.
The Farkles were facing a significant expatriation tax due to Jane’s ownership in a fully depreciated Miami apartment building she owned with her sister. As discussed in prior blogs, an expatriating individual (subject to certain thresholds) is generally subject to income tax on the net unrealized gain in his or her property as if the property had been sold for its fair market value on the day before the expatriation date, but up to $693,000 (2016 amount) of gain can be excluded. Certain assets, such as eligible deferred compensation, are excluded from the “deemed sale” calculations and are taxed under a different set of rules.
Although Jane would get an increased basis in the Miami property for U.S. tax purposes due to the expatriation tax, John and Jane learned that a later disposition of the property would result in taxes due to their foreign country of residency based on gain calculated using the original basis. This would cause much of the gain to be taxed twice, once in the United States and then again, at a later date, in their foreign country of residency. They also learned that Jane’s continued ownership of the Miami property, after expatriation, would create continued U.S. taxation issues.
Although they were initially moving full speed to renounce their U.S. citizenship and apply for citizenship in their new adopted country, they had to place the expatriation process on hold and reevaluate the situation.
After consulting with their foreign and U.S. tax advisors, John and Jane contacted Jane’s sister to see if she was interested in purchasing Jane’s half of the Miami property, which she was. Selling the property creates a somewhat larger U.S. tax liability due to reporting the taxable gain without the use of any of the $693,000 exclusion allowed against total expatriation gains. However, being able to report the gain on their U.S. and foreign income tax returns in the same tax year enables them to get a credit against their foreign taxes for the U.S. tax paid on the gain, avoiding the double taxation issue.
Because Jane’s sister is able to refinance the property, Jane gets cash at closing that can be used to pay her U.S. tax liability. Although both John and Jane’s net worth still exceed the threshold for when the expatriation tax calculations apply, neither owes any expatriation tax due to the $693,000 exclusion amount. They can’t escape U.S. tax on their retirement accounts, but they elect to pay that tax through withholding when they begin taking distributions.
John and Jane know that a remaining concern is the special estate and gift tax rules that apply to covered expatriates leaving gifts or bequests to U.S. citizens or residents. Although John and Jane were ready to give up their U.S. citizenship, they felt their children should be allowed to make their own choice once they became adults. So if the children decide to hold onto their U.S. citizenship, there could be U.S. tax issues years from now.
We hope you enjoyed this blog series on expatriation. Our International Tax Group is ready to assist you with any questions you might have. You can email us at firstname.lastname@example.org or call at 607-272-5550.