Quick balance sheet question for Form 8854

One of the eternal struggles is the effort to bring an expatriate's net worth below the $2,000,000 mark. Success here means that the person escapes the United States without being a "covered expatriate" and thereby incurring a potentially massive tax cost for doing so.

Questions come up all the time about how to do this. Investments of various types are considered. Mortgages are considered. None of these strategies work, typically.

Buying Real Estate With Mortgages

One such question came in tonight (hey, it's Sunday night, I'm writing blog posts and listening to streaming psybient; life is good!). It's a good kickoff for this topic.

I am a covered expat and trying to get my finances down in order to renounce. One question: if I buy a house for $600,000 and put down only $100,000, will I be able to show a liability of $500,000 and only an asset of $100,000 for the house?

This will not reduce the person's net worth. Consider the before and after pictures:

Before

• Assets = cash = $100,000
• Liabilities = none
• Net Worth = Assets Minus Liabilities = $100,000

After

• Assets = cash = zero
• Assets = real estate = $600,000
• Liabilities = Mortgage = $500,000
• Net Worth = Assets Minus Liabilities = $100,000

Pure Borrowing Won't Work

Simply taking on a debt will not reduce your net worth, either. Let us pretend that you go to your next door neighbor and say "I want to borrow $1,000,000". Your neighbor happily obliges and you sign a promissory note. You are legally in debt for $1,000,000, and this debt indeed reduces your net worth by $1,000,000.

However, something else happened when you signed that promissory note. Yes, you went into debt. But you also received $1,000,000 cash money.

Here is the before and after picture:

Before

• Assets = cash = $0
• Liabilities = debt = $0
• Net Worth = Assets Minus Liabilities = $0

After

• Assets = cash = $1,000,000
• Liabilities = debt = $1,000,000
• Net Worth = Assets Minus Liabilities = $0

The only way this strategy can work is if you find a way to somehow borrow money (and owe a debt to someone) without actually receiving any money from the lender. And this, of course, is not a loan at all but is some sort of BS. I take that back. I have seen people successfully end up with debt and no assets in divorces. A divorce, of course, has its own costs.

What Does Work

You can only reduce your net worth for Form 8854 purposes by actually not owning the asset anymore. That means you must either spend the money or give it away.

Pay Income Tax

One good way of spending money is by paying income tax that you are going to have to pay anyway. If it is a question of timing only:

• Do I pay the income tax before I expatriate, thereby reducing my net worth? or
• Do I pay the income tax later (after I expatriate)? or
• Do I pay the income tax when I expatriate as a covered expatriate?

Sell assets, get cash, pay tax. Think of this for both the United States and the country that you are living in now. Or find ways to reconfigure your life that are treated as taxable sales even if nothing really changes beneath the surface. (Exploit anomalies, in other words).

Also, be very careful about the exit tax you would pay in the United States as a covered expatriate. I suspect you will find it difficult and/or impossible to claim a foreign tax credit in your home country for this tax paid to the United States. I like to force real taxable events on both sides of the border whenever people are faced with exit taxes. I'm looking at you, Canada. You have an exit tax and so do we. Don't have an artificial non-event occuring in Canada that triggers tax but there is no real taxable event in the United States that permits a foreign tax credit. Or vice versa.

Gifts

Gifts are the primary way of quickly reducing net worth. They are easy and bulletproof. You have the unified credit amount to work with -- you can give away up to $5.43 million (2015's number) without triggering a gift tax. Make the gift (and be sure it is a "completed" gift). File a gift tax return. Bang, you're done.

Don't Do Stuff Like This

The "I went to Las Vegas last weekend and lost 40% of my net worth" stuff doesn't work, needless to say. The IRS didn't fall off the watermelon truck yesterday. They ain't dumb. Examine your ideas and make sure they rely on reality rather than "How will the IRS ever find out?"