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April 21, 2012 - Phil Hodgen

Property you acquired before coming to the USA

This is a quick little blog post to answer a recurring question for many people out there.  It came up in the course of some work I am doing right now.

Situation

You are a nonresident of the United States.  Thirty years ago you bought a piece of land in your home country for US$10,000.  Now it is worth US$200,000.

You immigrate to the United States, then sell the land for its current value — US$200,000.

Question

Do you pay U.S. capital gain tax on the entire $190,000 of capital gain?

Answer

Yes.

Why

Just because you change status from nonresident to resident of the United States, you don’t change the U.S. tax laws that apply to your transaction.  Unfortunate but true.  You calculate your U.S. tax results using U.S. tax law, despite the fact that you were a nonresident when you bought the property.

From 1998 FSA LEXIS 402:

In several cases, the Tax Court has determined the adjusted basis of property acquired by a U.S. taxpayer outside the U.S. before becoming a U.S. resident. The court has assumed as the starting point the taxpayer’s appropriate basis under U.S. tax principles. Compare Gutwirth v. Comm’r, 40 T.C. 666 (1963) (1939 Code) and Benichou v. Comm’r, T.C. Memo 1970-263 (taxpayer’s basis was initial cost) with Reisner v. Comm’r, 34 T.C. 1122 (1960) (taxpayer’s basis was fair market value upon inheritance). In general, the taxpayer’s cost basis for purchased property has been determined to be the initial expenditure in the foreign jurisdiction.n5 See Heckett v. Comm’r, 8 T.C. 841 (1947).

The same idea is true if you acquired the property by inheritance.  Your acquisition basis (and therefore the starting point for calculating capital gain) is the date of death value for property.  (Date of death = the date the person from whom you inherited the property died).

But I digress . . .

The Reisner v. Commissioner case contains an interesting little tidbit of information for those of you handling World War II restitution cases.  (Yes, I still run into this every so often, most recently in an OVDI case).  There a gentleman was forced to sell property in Berlin in 1937.   He had inherited the property in 1926 from his parents.  After the war he recovered the property under an order of restitution — Order No. 49 by the Allied Berlin Kommandatura.  The legal effect of this order told the Tax Court everything it needed to know about calculating the basis of the buildings in the hands of the taxpayer.

The order said that anyone receiving restitution under the order would be treated as if he had an unbroken chain of title — that the property had always been his.

This gave the Tax Court an easy way to determine the basis of the buildings in the hands of the taxpayer — date of death valuation in 1926 plus the cost of capital improvements.

It is rare that you find a non-tax fact so clear as that postwar order.  Usually these World War II restitution cases are messy in the extreme.

I’m back now

And the results of this case give us clear guidance on how you should handle your capital gain tax for the year of sale.  This gentleman was deemed to have acquired the property by inheritance while a nonresident of the United States.  He got the 1926 acquisition cost (calculated under U.S. tax law).

Exception for exit tax

There is a weird little exception for people who expatriate.  Green card holders.  I will write a blog post about this later.  If you come to the United States, stay long enough with a green card, then leave the country and are subjected to the exit tax (Section 877A; go see Form 8854), you can use the “date of entry” value to calculate your capital gain for purpose of the mark-to-market gain.

All gibberish for those of you who don’t live inside the Holy Temple of Exit Tax, I’m sure.  Here’s an example.

You are a nonresident of the United States.  Thirty years ago you bought a piece of land in your home country for US$10,000.  Now it is worth US$200,000.

You immigrate to the United States, stay for 10 years, and then say “Oh, (blankety blank blank).  I’m outta here!” and relinquish your green card.  You still have the land.  At that point it is worth $300,000.

For exit tax purposes (assuming you are a “covered expatriate”) you are deemed to have sold the land at fair market value on the day before you gave up your green card.  So you’re treated as selling at $300,000.  Lucky for you, though, you get to use the value of the property on the day you came into the USA — $200,000 — to calculate that exit tax.  So you only pay tax on $100,000 of capital gain.  Make-pretend capital gain.  Lucky you.

Yeah

We need more unnecessary complexity.  Please Congress — write more ill-conceived tax laws charmingly devoid of common sense and jet-fueled by partisan lobbyists and Poli Sci majors burnishing their resumes with three years of work on the Hill, all with an ideological ax to grind and a pocket to stuff with government largesse.  (Who by the way couldn’t spell “If A, then B” if you handed them both letters).  (Both parties offend me; spare me your tortured outrage.  I’ve received too many emails saying “How COULD you??? Are you one of THEM?????” emails).  (But I’m not bitter.)

Sigh.

Nonresidents with US Activities