Ever wondered if the US taxes foreign currency gains? Well, many of our clients do, and we’re frequently asked questions on whether the transfer of money from the US or investing overseas will result in foreign currency gains.

As part of our Explainer series, we’ll briefly cover here some of the considerations of what a foreign currency gain is.

What is a foreign currency gain?

A foreign currency gain occurs when the value of a particular transaction changes due to exchange rate fluctuations.

Lets imagine you live in the USA, and you have an NZ mortgage for a rental property in NZ.

Now, lets say the mortgage was $700,000 when you took it out in 2008, which at the time was worth $500,000 USD.

So, we know, for US tax purposes, you had taken out a $500K USD mortgage.

For the purposes of this article, and for simplication, lets imagine you made no mortgage payments at all between purchase date in 2008 and sale date.

Then, lets say you paid off $700,000NZD in 2023 due to a sale of the property. But the exchange rate had changed, and the total amount paid off was only worth $400,000USD.

We now have a situation where, the mortgage you paid off was $100,000 USD less than it was originally taken out for, even though the NZD amount you paid off was exactly the same.

This above, is a foreign currency gain.

Using another example, lets imagine you purchase an NZ government bond for $1000, which has a 5 year maturity. At the time of purchase, the $1000 bond was worth $700USD.

Now, 5 years later, you get your $1000 back from the bond, but the exchange rate says its now worth $800USD.

Again, we have here a $100 USD foreign currency gain.

Does the USA Tax Foreign Currency Gains?

Yes, under US tax law, foreign currency gains are taxable, but only in certain situations.

This is dealt with through Section 988 of the US tax code. This section defines what transactions may be subject to foreign currency gains, and where a gain needs to be calculated.

In summary, a Section 988 transaction (one which requires foreign currency gains to be calculated) is of course, always a transaction that has occurred in a currency other than USD. Types of Section 988 transactions include (but not limited to):

- Repayment of a debt instrument, such as a mortgage

- Income being accrued for a later date (for example, agreeing to receive payment much later than the income was earned, usually the case for athletes or artists)

- On a futures contract. This covers things like bonds, where you are to receive money in future for a payment you make now

Fortunately, US tax on foreign currency gains is limited, and generally speaking, doesn’t capture things like term deposits, bank accounts or credit cards.

Does New Zealand Tax Foreign Currency Gains?

Indeed, New Zealand does also tax foreign currency gains in certain circumstances, under a set of rules named the “financial arrangement rules”.

We can provide referrals to NZ tax specialists who can advise on the detail of this.

Summary

If you’re planning on investing overseas or here in New Zealand, it is always worth seeking US tax advice first.

We also work with a range of NZ tax specialists, and investment specialists who can help you manage these different tax issues in an efficient way.

To discuss further, reach out today on 09-242-3445 – info@usatax.nz