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Arthur Rubin
Arthur Rubin, Tax Preparer
Category: Tax
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Experience:  22 years of tax preparation experience, including individual, trust, and estate returns.
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Schedule E and 1116: High expenses on my foreign rental property

Resolved Question:

Schedule E and 1116: High expenses on my foreign rental property are limiting my foreign tax credit.

My wife and I have income for a house in the UK that we bought in 2011. 2012 was the first year for which we received rental income and, as it was the first year, we had a relatively high level of expenses.

The high level numbers are:

Income = $35,000
UK Tax Paid = $5,000
Expenses = $20,000
Depreciation = $12,000

When I enter these details into Schedule E, my effective income becomes $3k (ie total rent minus expenses and depreciation). This makes sense to me.

When I complete 1116, the fact that my expenses are high means that my net income for the property is (as above) $3k which limits the tax I can claim. As a result of this, I can claim only $3k of my foreign tax credit which is lower than the amount I actually paid.

Because the UK does tax on a slightly different calendar (April 5 2012 to April 5 2013 is the current year), although I do expect to get a refund from there, I won't get it until September 2013 (when I file for the appropriate year).

Therefore, what do I do? Is there some way to get a higher foreign tax credit now given the fact I did pay a lot of tax in the UK? Or do I file as above, wait for my UK taxes, hopefully get a refund there and then refile my US taxes now with a lower tax number?
Submitted: 1 year ago.
Category: Tax
Expert:  Arthur Rubin replied 1 year ago.

Arthur Rubin :

Thank you for using Just Answer.

Arthur Rubin :

I don't have a complete answer, as I can't verify fully the effects of the overlapping tax years.

Arthur Rubin :

However, the law is clear that the tax refund you expect to get in September 2013 will require amending your 2012 return. If you elect the cash method of reporting on Form 1116, I would prorate the refund according to the taxes paid in the respective years; i.e., if you paid $500 in taxes in 2012, and $300 in 2013, and receive a refund of $80, you would allocate the refund $50 to 2012 and $30 to 2013. If you elect the accrual method, then I would allocate both the tax paid and the refund according to the amount of rent received in 2012 and 2013 relating to the 2012/13 UK tax year.

Arthur Rubin :

If you received rent in the UK 2011/12 tax year, you need to allocate the tax to 2012.

Arthur Rubin :

I'm going to be off-line from at least 8 am until 9 pm Pacific Time on both Saturday and Sunday, so please bear with me, if you have further questions.

Customer:

I think that answers my question. To confirm (make sure I have it right):

Customer:

1) I have declared this all correctly for now and that does mean that I appear to be out of pocket (ie I paid $5k of taxes to the UK, but received only a $3k credit from the US.

Customer:

2) If and when I get any refund to the tax paid in the UK, I should re-file the US taxes. As you say, I should pro-rate the tax paid in the UK across the relevant US years, using income as my pro-rate ratio?

Customer:

Thanks!

Arthur Rubin :

Almost completely correct.

Arthur Rubin :

In regard point 1, if your calculations are correct, the $2K can be carried back one year and forward up to 10 years toward years in which you have foreign income which is not taxed as much in the UK as in the US. In reality, it hardly ever happens, but, it is possible.

Arthur Rubin :

For point 2, you have the option of calculating the form 1116 on either the tax paid or tax accrued.

Arthur Rubin :

You normally cannot change from one to the other in successive years, without the permission of the IRS.

Arthur Rubin :

If you select tax paid, your initial 2012 form 1116 is based on taxes actually paid in 2012, and refunds for a specific UK tax year are prorated by the taxes paid.

Arthur Rubin :

If you select tax accrued, taxes paid toward your 2012/2013 UK tax return, and your refund, are prorated between US 2012 and 2013 tax returns based on income.

Arthur Rubin :

This decision is independent of whether you choose the cash method or the accural method on your US tax returns, and (if you have the option) on your UK tax returns. I would normally recommend using the accural method for taxes based on an actual foreign business.

Arthur Rubin, Tax Preparer
Category: Tax
Satisfied Customers: 1260
Experience: 22 years of tax preparation experience, including individual, trust, and estate returns.
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