How to Handle Taxation on Foreign Rental Income

March 26, 2025
How to Handle Taxation on Foreign Rental Income

Introduction

Owning rental property in a foreign country can be a lucrative investment, but it comes with tax obligations in both the foreign country and the taxpayer's home country. Many countries impose rental income taxes, and U.S. or Canadian taxpayers must also report their global income, including foreign rental earnings, to their respective tax authorities.

 

This article outlines how foreign rental income is taxed, how to claim deductions and foreign tax credits, and the best strategies to avoid double taxation.

 

1. Reporting Foreign Rental Income

  • United States (IRS Rules):
    • U.S. citizens and residents must report all rental income worldwide on Schedule E (Form 1040).
    • Foreign currency amounts must be converted to USD based on the exchange rate at the time of income received.
  • Canada (CRA Rules):
    • Canadian residents must report foreign rental income in CAD on their T776 – Statement of Real Estate Rentals.
    • The CRA taxes foreign rental income at the same rate as domestic rental income.

 

2. Deductible Expenses for Foreign Rental Properties

Taxpayers can deduct reasonable expenses related to maintaining the rental property, such as:

  • Property management fees
  • Mortgage interest (not principal)
  • Repairs and maintenance
  • Insurance costs
  • Property taxes and local rental taxes
  • Utilities (if paid by the owner)
  • Depreciation (U.S. only, not Canada)

 

3. Foreign Tax Credits and Tax Treaties

  • If foreign rental income is taxed in another country, U.S. and Canadian taxpayers may avoid double taxation by claiming:
    • Foreign Tax Credit (FTC) (U.S. – Form 1116, Canada – Form T2209)
    • Tax treaty benefits (if an agreement exists between both countries)
  • Example:
    • A U.S. taxpayer earns rental income from a property in France and pays French rental income tax.
    • The IRS allows a foreign tax credit to offset U.S. tax liability.

 

4. Depreciation Rules for Foreign Rental Properties

  • U.S. Depreciation (MACRS Method):
    • Foreign residential properties are depreciated over 30 years instead of 27.5 years for U.S. properties.
    • Depreciation must be reported using Form 4562.
  • Canada (CRA Rules):
    • Depreciation (Capital Cost Allowance - CCA) is optional but may lead to recapture tax if claimed and the property is later sold.

 

5. Passive Foreign Investment Company (PFIC) Considerations

  • If a taxpayer owns foreign rental property through a foreign corporation, it may be classified as a PFIC, triggering additional U.S. reporting (Form 8621).

 

6. Exchange Rate Considerations

  • All rental income, expenses, and capital gains must be converted into the taxpayer's home currency using the appropriate exchange rate at the time of each transaction.

 

7. Tax Implications When Selling a Foreign Rental Property

  • Capital Gains Tax:
    • The gain is subject to tax in both the foreign country and the home country.
    • U.S. taxpayers must report gains on Schedule D & Form 8949.
    • Canadian taxpayers must report gains in CAD and may be eligible for a foreign tax credit.
  • Foreign Withholding Taxes:
    • Some countries impose withholding taxes on property sales, which may be creditable against home country taxes.

 

8. Required Tax Forms for Foreign Rental Income

  • United States:
    • Schedule E (Form 1040) – Rental income reporting
    • Form 1116 – Foreign tax credit
    • Form 8938 – FATCA reporting if total foreign assets exceed the threshold
    • FBAR (FinCEN 114) – If the taxpayer holds a foreign bank account related to the rental property
  • Canada:
    • T776 – Statement of Real Estate Rentals
    • T1135 – Foreign Income Verification Statement (if foreign property value exceeds CAD 100,000)
    • T2209 – Foreign Tax Credit Application

 

Conclusion

Taxation on foreign rental income requires careful compliance with both local and home country tax rules. Proper reporting, claiming deductions and foreign tax credits, and understanding exchange rate implications can help taxpayers minimize tax liability and avoid penalties. 

 

Tax Partners can assist in navigating complex international tax rules, ensuring compliance while optimizing tax savings on foreign rental income.

 

This article is written for educational purposes.

 

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

 

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

Back to Articles