Impact of citizenship and residency on taxes on property sales

April 24, 2024

INTRODUCTION

In this issue of parallel universes, through the scenarios of Dev and Sukriti, we’d like to illustrate how citizenship and residency can impact the taxes you pay on property sales, and life-stage and timing can influence your decision making.

From Dev’s Perspective

Dev grew up in Nasik, and moved to the US when he was in twenties to study and then to work. Many years later, when he had children, nostalgia for his hometown kicked in and that led him to purchase a beautiful piece of land with papaya and banana trees, mainly for family vacations and perhaps spending a few years there when they were older. However, as the years went by, Dev and his wife found it harder to take long breaks from their careers to take their children to Nasik. As the children grew up, they developed interests and an independence of their own. Today, Dev’s children do not intend to live in India. Dev is not so sure he wants to retire there either, and as he grows older he worries that this isn’t an easy asset to manage.

Problem

In the last month Dev has called us several times. He has decided to sell his farm house in Nasik, and wanted us to advise him on the capital gains taxes he might have to pay.

Solution

While advising Dev, we examined his situation to see if we could use Section 121 (exemption of gains on sale of primary residence). If Dev is subject to taxes in the US on worldwide income, he is entitled to use the US rules to his advantage too, which in this case would mitigate the need to transfer to an Indian person or make the sale happen via his relative. Unfortunately in Dev’s case, since he hardly spent more than a few weeks every year at his Nasik home, it would be difficult to apply for Section 121.

Really, what Dev needs to take a call on is whether he wants to use some tax saving strategies that are available in India. It is a fine balance. He needs the taxes paid in India to credit the tax bill in the US. If he uses options in India to save taxes, he might be robbed of the option to use up credits in the US. As a result his tax bill in the US could be large. This coupled with a reinvestment in India (were he to have one) could pose severe cash flow challenges.

From Sukriti’s Perspective:

Sukriti, our client in Bangalore, had spent a long while in the US, in Massachusetts and then California. She had gone to Swarthmore for her undergraduate studies in Political Science and Philosophy, and after a law degree she worked with several firms on policy making. Sukriti is in her fifties today, and she has been keen on moving to India to work with non-governmental and research bodies on policy making in India. Sukriti is a US citizen today, and she owns a charming brownstone in Massachusetts.

Problem

Before her move to Bangalore last year, Sukriti leased her property and was claiming the rent received as rental income. Around 12 months into her move, it became clear to Sukriti that she would live in Bangalore for many years. Sukriti now wants to sell her home in Massachusetts.

Solution

Since Sukriti’s property is located in the US, taxes would hit her the same way whether she made the sale from India or the US. However, if Sukriti waits for another 2 years, by which time she would have lived in India for 3 out of the previous

5 years, she would be eligible for capital gains exemption.

Since she still lived in her US property for 2 out of the last 5 years, from a US standpoint, she can claim Section 121, or principal home residence (the maximum window for this is 5 years, after which you can no longer claim that physical property as your Principal Home). If a US person sells their Principal Home Residence (i.e. their primary/ main residence), the capital gains for a single person is tax free up to $250,000 (it’s $500,000 for a married joint filing couple). What we usually advise is to not lease your US property for more than 2-3 years. Once you fulfil the 2 out of 5 years, sell your property so that you qualify for the $500k exemption.

EXPLANATION

In Dev’s case we cautioned him that the US has a Net Investment Income Tax of 3.8% at a Federal level and some states have a state tax in addition. To avoid this, Dev could consider selling the property via one of his siblings or many nieces and nephews in India. That way, it would still attract the Indian tax (which would be incurred either way), but he avoids the US Net investment income tax. Also, an Indian resident selling a property is subject to a low 1% TDS on the sale proceeds vs a non-resident Indian who is subject to the 20% plus Cess and surcharge withholdings at source. So in addition to saving on taxes, by selling through one of his relatives (or anyone else he trusts), Dev lowers his risk of having to labour with the Indian tax authorities to secure a refund; after all, his TDS far exceeds his tax bill on the sale were he to sell as an NRI.

All this considered, we also made Dev aware that the downside of selling through an Indian person is that his ability to take funds out of India will be drastically decelerated by FEMA. If Dev is going to need those funds for a life event in the next few years, such as his children’s college, this might be something to take into account.

Property sales in India can still result in a state tax bill because states do not allow foreign tax credits. Abandoning state domicile in a taxable state may not be easy practically speaking, because Dev and his wife have an active career in California. One way to approach this is to realize that the very purpose of these property investments was to provide financial independence for retirement years. We recommended making the most of it rather than giving away a significant chunk in state taxes. Breaking domicile could be worth it if the transaction runs into many millions.

In Sukriti’s instance, to maximize her tax saving from an Indian standpoint, she can be vigilant about the timing of her sale. If she sells just as two years in Bangalore comes to a close, she would be selling while she is still a RNOR (Resident, but Not Ordinarily Resident), which means she will not have to declare worldwide income in India. If she waits too much longer, she would be an ROR, and will have to declare the income from the US property sale. If she waits for much longer, she will not even qualify for the Principal Home Residence tax exemption. The goal here is therefore to balance the tax savings under the Primary Home exemption in the US with the RNOR status in India..

Contact Ventura Pranas, for such customised solutions to complicated tax-related issues.