Seems like I am getting a call every day on U.S. taxation of home loans in foreign (non-U.S.) currencies. As a foreign currency drops in value, the value of a debt (in U.S. dollars) decreases and the IRS wants to tax this windfall.
For example, I owe you 1 (one) British pounds. When I made the loan, the one pound cost a U.S.$1.50. Now, the pound is worth $1.00. So, I only have to spend a dollar to pay you back. The IRS issued a ruling (which is merely an opinion), that repayment of the loan creates $.50 in taxable income.
CPAs are adding to the confusion by misreading section 988 regarding the sale of financial instruments. Section 988 merely converts part of the gain into ordinary income. Section 988 attempts to separate the gain due to changes in the interest rate of debts. It does not create taxable income.
But here is the big tax problem with section 988 and currency gains from devaluation in the thinking of many CPAs.
This no gain when you pay off a home loan in a foreign currency that has devalued. Okay, your CPA insists that you owe taxes on the repayment of a debt. So, let’s say your CPA is your neighbor. He needs a dozen eggs and you kindly loan him the eggs. At the time you bought the eggs they cost $5 a dozen.
The CPA pays back a month later and at that time a dozen eggs cost $2. Does your CPA think he has taxable income? Well, I can tell you that the U.S. Supreme Court has ruled there is no taxable income. By the way, the U.S. Supreme Court is the law of the land. The Court overrides all IRS rulings and regulations and even the opinion of a CPA See the Supreme Court decision (by the way, the IRS does not overrule the Supreme Court) Kerbaugh-Empire Company, 271 U.S. 170, May 3, 1926.).
There is another Supreme Court cases that both your CPA and IRS are supposed to know. This case deals with refinancing your home loan. Supreme Court in Cottage Savings Ass’n versus the IRS Commissioner, (499 U.S. 554 (1991)) created a tax law. When a court creates a tax law, it is called a “common law”.
Most of us have used this tax law without knowing it. Every time we refinance our home, this case is the reason we do not have a taxable event. Obviously, we have saved money by refinancing for a lower interest rate loan. We have increased our wealth because it is cheaper to pay off our loan.
It is exactly this windfall that the IRS wants to tax. The Court has this rule refinancing must be loans that were made to different obligors and secured by different homes. Loans with different obligors (lenders) do not create a taxable event is the loans have substantially similar terms.
Need more tax savings information on section 988, currency devaluation and home loans, then please click here.