My client inherited a house in the UK. It;s value was 100,000 pounds or $185,000 on the date of death. Now it has been sold for 80,000 pounds which is now $128,000 (the exchange rate has become more favorable to the dollar). The house was not used by anyone since the date of death so it is an investment property and a loss can be deducted. The question is, what is the loss? Is it $57,000 which is coming both from the drop in value and the change in exchange rate, or is the loss figured by subtracting $148,000 (the value of 80,000 pounds on the date of death) from $180,000 which is a $32,000 loss, or some other way?
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Pub 514 deals with the foreign tax credit. However, page 4 under Foreign Currency and Exchange Rates contains principals that apply to other areas of tax law. I believe it probably applies to your question as well.
I think what it is saying is: If your functional currency is the U.S. dollar, you immediately translate everything that happens into U.S. dollars at the time it happens. This may mean doing it a number of times throughout the year. Thus, I would translate the foreign currency in U.S. dollars at the time the house was inherited, and then again at the time it was sold.Foreign Currency and Exchange Rates
U.S. income tax is imposed on income expressed in U.S. dollars, while the foreign tax is imposed on income expressed in foreign currency. Therefore, fluctuations in the value of the foreign currency relative to the U.S. dollar will affect the foreign tax credit.
Translating foreign currency into U.S. dollars. If you receive all or part of your income or pay some or all of your expenses in foreign currency, you must translate the foreign currency into U.S. dollars. How you do this depends on your functional currency. Your functional currency generally is the U.S. dollar unless you are required to use the currency of a foreign country.
You must make all federal income tax determinations in your functional currency. The U.S. dollar is the functional currency for all taxpayers except some qualified business units. A qualified business unit is a separate and clearly identified unit of a trade or business that maintains separate books and records. Unless you are self-employed, your functional currency is the U.S. dollar.
Even if you are self-employed and have a qualified business unit, your functional currency is the U.S. dollar if any of the following apply.
• You conduct the business primarily in dollars.
• The principal place of business is located in the United States.
• You choose to or are required to use the dollar as your functional currency.
• The business books and records are not kept in the currency of the economic environment in which a significant part of the business activities is conducted.
If your functional currency is the U.S. dollar, you must immediately translate into dollars all items of income, expense, etc., that you receive, pay, or accrue in a foreign currency and that will affect computation of your income tax. If there is more than one exchange rate, use the one that most properly reflects your income. You can generally get exchange rates from banks and U.S. Embassies.
If your functional currency is not the U.S. dollar, make all income tax determinations in your functional currency. At the end of the year, translate the results, such as income or loss, into U.S. dollars to report on your income tax return.
On the other hand, if your functional currency is not the U.S. dollars, then you compute all transactions in the foreign currency, and then translate all transactions once at the end of the year into U.S. dollars.Last edited by Bees Knees; 10-29-2008, 03:06 PM. -
Kram
Kram after reading Bees' response, I tried to plug it in to your parameters to calculate a dollar amount. Clearly the loss is $57K.
However the loss consists of two elements, $32K in drop in UK value, plus another $25K attributable to currency.
My question: Is ALL of this a capital loss? or is the $25K portion deductible (or taxable) at ordinary income rates?Comment
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