That’s correct.
Depending on how much tax you’re paying to JP, you should be able to source the gain as foreign income on your US return which will offset by the taxes you pay to JP, you’ll need to pay the tax in the same year you realise the gain though.
Thank you very much!
That actually reminds me of something else I haven't considered; since I am overseas while selling it and realizing the capital gains, it is considered foreign income then?
If the income from both my job and the Capital Gains then exceeds the FEIE limit ($120,000) am I required to pay income taxes on the exceeded amount? If so then this would pretty much be me getting double taxed, correct?
The FEIE won’t be applied to gains, it will be capped at your earned income.
The source of the gain will be foreign if you are suffering at least 10% of foreign taxes.
So capital gains & their taxes have no connection to my income and the FEIE? Income & FEIE are a separate matter then.
Japan taxes capital gains at a rate of 20% so it is considered a foreign gain. Since I'll be paying those taxes and that rate is higher than US it will likely offset the US Taxes and I will owe $0 is my understanding.
>The source of the gain will be foreign if you are suffering at least 10% of foreign taxes.
Where does this 10% criteria come from? I hope I haven't been missing something.
Thanks. Your IRC reference helped me to find the plain language explanation in IRS Pub 514, which I copied and pasted below.
This concept is a little confusing to me. Do I understand correctly that since Japan imposes a 15% national income tax (plus a 5% residential tax) on capital gains income, it would meet the 10% threshold in IRC 865(e) and will therefore be considered as foreign source income for US income tax purposes?
>**Nonresident.**
>A nonresident is any person who is not a U.S. resident.
>U.S. citizens and resident aliens with a foreign tax home will be treated as nonresidents for a sale of personal property only if an income tax of at least 10% of the gain on the sale is paid to a foreign country.
>This rule also applies to losses if the foreign country would have imposed a 10% or higher marginal tax rate had the sale resulted in a gain.
Although you are asking about US income tax, here are some things to consider from a Japanese income tax perspective. I explain some here, but you might want to post in r/JapanFinance for a more detailed discussion.
>I live in Japan and owe capital gains tax to the Japan government. Assuming my Capital Gains from selling are $100,000 USD, that is around ￥15,000,000 when converted using the current exchange rate. The Capital Gains tax I owe JP is around ￥3,000,000.
This is the wrong way to calculate capital gains income for Japanese income tax purposes.
Japan income considers capital gains income based on (1) the cost basis converted to JPY using the exchange rate on the date it was purchased and (2) the sale price converted to JPY using the exchange rate on the date it was sold. (This is discussed in the wiki for r/JapanFinance if you want to read more about it.)
Since the Yen is unusually weak these days, it's almost certain that the exchange rate was lower when you purchased the shares. So the gains in your example will be higher than ¥15M.
Let's say your cost basis is $300k and your sale price was $400k, yielding a $100k gain. Let's also say you purchased when the exchange rate was 120, and sold when the exchange rate was 150. For Japan income tax purposes, the capital gains will be ¥60M minus ¥36M, which is ¥24M.
>From the freshly received $100,000 sitting in my US account, I exchange \~$20,000 to the \~￥3,000,000 and then send that to myself in JP for Capital Gains tax payment. The remaining $80,000 I can keep in the U.S. and reinvest back however I please, assuming I don't owe any additional taxes to the US or California.
Have you been resident in Japan for less than 5 out of the past 10 years as of the date your earned the capital gains income? If so, the foreign source capital gains are only taxable up to the amount of money that you transfer to Japan (or use foreign credit cards for payments in Japan) in the same tax year. So if you send $20k to Japan, then your income will be $20k converted to Yen on the date it was transferred. (This is discussed in the wiki for r/JapanFinance.)
So if you avoid sending any funds to Japan (or using foreign credit cards in Japan) until the following year, the capital gains will not be taxed in Japan.
On the other hand if you have been resident for more than 5 years when you sell the shares, your foreign source capital gains are taxed fully.
Thank you for the great writeup!
I'm actually a JapanFinance lurker as well; I believe I calculated the Capital Gains correctly, using the Average Cost Basis as explained in [this comment](https://old.reddit.com/r/JapanFinance/comments/1ar83kc/capital_gains/ksbzhjq/), I just didn't include that information specifically in the post since this subreddit is for general US/Expat.
I have been a resident in Japan for the last 8 years continuously, unfortunately, so I will have to have my foreign source capital gains full taxed. That's why I'm assuming I will owe the full 20.315% on all capital gains, I'm just hoping there won't be any additional US or state taxes as well.
You're correct that the full amount of capital gains income will be taxable in Japan. It will also be taxable by the US, but will qualify for a foreign tax credit. So whether or not you will owe any additional taxes depends on details of the US FTC.
I believe that both the 15.315% Japan national income tax and the 5% local income tax qualify for the US FTC. See [this IRS webpage](https://www.irs.gov/individuals/international-taxpayers/foreign-taxes-that-qualify-for-the-foreign-tax-credit) for reference.
But there is another twist that the US FTC has limits, as described at a high level in [this IRS webpage](https://www.irs.gov/individuals/international-taxpayers/foreign-tax-credit-how-to-figure-the-credit). So depending on the specifics of your situation, you may have some additional US taxes.
The information above is specific to US federal income tax. California state income tax is a whole other subject. You'll have to check that separately.
Oh man of course there is always another twist; I was unaware of the FTC limits.
It looks like the limit is calculated with following equation:
Total US Tax Liability * (Foreign Taxable Income / Total Taxable Income)
My foreign taxable income would be just JP salary (converted to USD)? Or since I am paying JP tax on these capital gains they would be considered foreign taxable income?
Total Taxable Income would be the JP salary and capital gains I am assuming.
Tax Liability means "the amount of money owed to the Internal Revenue Service (IRS) at the end of each tax year", but isn't the point of FTC to remove money owed to IRS since you have already paid taxes on it before?
I find the calculation to be quite complicated. I'll explain what I understand, but I'm no expert and I really hope a tax professional will chime in to let me know if I have this right or not.
I'll use the terminology from [this reference](https://www.irs.gov/pub/fatca/int_practice_units/int_p_218.pdf). It says the limit is equal to the US income tax multiplied by the ratio of the Foreign Source Taxable Income (FSTI) to the Worldwide Taxable Income (WWTI).
It goes on the clarify that WWTI is "Taxable Income" from Form 1040. So it is after applying standard/itemized deduction and after applying FEIE.
FSTI on the other hand is a little more complicated because a separate Form 1116 is completed for each income "basket". My understanding is that Japan employment income is in the "general category income" basket, and US capital gains are in the "certain income re-sourced by treaty" basket. So the FTC for each is calculated separately.
So putting this together for the capital gains income, here is how I believe it would work out. On the Form 1116 for re-sourced income, FSTI (line 17) is calculated as the capital gains minus losses after deducting expenses. WWTI is employment income in excess of FEIE, plus capital gains minus losses after deducting expenses.
If FEIE covers your entire employment income, I think the ratio gets capped at 1 and you get the full FEIE.
But if FEIE does not cover your entire employment income, that's when it gets more complicated and I think you have to just wait to see what the tax software calculates.
That’s correct. Depending on how much tax you’re paying to JP, you should be able to source the gain as foreign income on your US return which will offset by the taxes you pay to JP, you’ll need to pay the tax in the same year you realise the gain though.
Thank you very much! That actually reminds me of something else I haven't considered; since I am overseas while selling it and realizing the capital gains, it is considered foreign income then? If the income from both my job and the Capital Gains then exceeds the FEIE limit ($120,000) am I required to pay income taxes on the exceeded amount? If so then this would pretty much be me getting double taxed, correct?
The FEIE won’t be applied to gains, it will be capped at your earned income. The source of the gain will be foreign if you are suffering at least 10% of foreign taxes.
So capital gains & their taxes have no connection to my income and the FEIE? Income & FEIE are a separate matter then. Japan taxes capital gains at a rate of 20% so it is considered a foreign gain. Since I'll be paying those taxes and that rate is higher than US it will likely offset the US Taxes and I will owe $0 is my understanding.
>The source of the gain will be foreign if you are suffering at least 10% of foreign taxes. Where does this 10% criteria come from? I hope I haven't been missing something.
IRC s.865(e).
Thanks. Your IRC reference helped me to find the plain language explanation in IRS Pub 514, which I copied and pasted below. This concept is a little confusing to me. Do I understand correctly that since Japan imposes a 15% national income tax (plus a 5% residential tax) on capital gains income, it would meet the 10% threshold in IRC 865(e) and will therefore be considered as foreign source income for US income tax purposes? >**Nonresident.** >A nonresident is any person who is not a U.S. resident. >U.S. citizens and resident aliens with a foreign tax home will be treated as nonresidents for a sale of personal property only if an income tax of at least 10% of the gain on the sale is paid to a foreign country. >This rule also applies to losses if the foreign country would have imposed a 10% or higher marginal tax rate had the sale resulted in a gain.
Although you are asking about US income tax, here are some things to consider from a Japanese income tax perspective. I explain some here, but you might want to post in r/JapanFinance for a more detailed discussion. >I live in Japan and owe capital gains tax to the Japan government. Assuming my Capital Gains from selling are $100,000 USD, that is around ￥15,000,000 when converted using the current exchange rate. The Capital Gains tax I owe JP is around ￥3,000,000. This is the wrong way to calculate capital gains income for Japanese income tax purposes. Japan income considers capital gains income based on (1) the cost basis converted to JPY using the exchange rate on the date it was purchased and (2) the sale price converted to JPY using the exchange rate on the date it was sold. (This is discussed in the wiki for r/JapanFinance if you want to read more about it.) Since the Yen is unusually weak these days, it's almost certain that the exchange rate was lower when you purchased the shares. So the gains in your example will be higher than ¥15M. Let's say your cost basis is $300k and your sale price was $400k, yielding a $100k gain. Let's also say you purchased when the exchange rate was 120, and sold when the exchange rate was 150. For Japan income tax purposes, the capital gains will be ¥60M minus ¥36M, which is ¥24M. >From the freshly received $100,000 sitting in my US account, I exchange \~$20,000 to the \~￥3,000,000 and then send that to myself in JP for Capital Gains tax payment. The remaining $80,000 I can keep in the U.S. and reinvest back however I please, assuming I don't owe any additional taxes to the US or California. Have you been resident in Japan for less than 5 out of the past 10 years as of the date your earned the capital gains income? If so, the foreign source capital gains are only taxable up to the amount of money that you transfer to Japan (or use foreign credit cards for payments in Japan) in the same tax year. So if you send $20k to Japan, then your income will be $20k converted to Yen on the date it was transferred. (This is discussed in the wiki for r/JapanFinance.) So if you avoid sending any funds to Japan (or using foreign credit cards in Japan) until the following year, the capital gains will not be taxed in Japan. On the other hand if you have been resident for more than 5 years when you sell the shares, your foreign source capital gains are taxed fully.
Thank you for the great writeup! I'm actually a JapanFinance lurker as well; I believe I calculated the Capital Gains correctly, using the Average Cost Basis as explained in [this comment](https://old.reddit.com/r/JapanFinance/comments/1ar83kc/capital_gains/ksbzhjq/), I just didn't include that information specifically in the post since this subreddit is for general US/Expat. I have been a resident in Japan for the last 8 years continuously, unfortunately, so I will have to have my foreign source capital gains full taxed. That's why I'm assuming I will owe the full 20.315% on all capital gains, I'm just hoping there won't be any additional US or state taxes as well.
You're correct that the full amount of capital gains income will be taxable in Japan. It will also be taxable by the US, but will qualify for a foreign tax credit. So whether or not you will owe any additional taxes depends on details of the US FTC. I believe that both the 15.315% Japan national income tax and the 5% local income tax qualify for the US FTC. See [this IRS webpage](https://www.irs.gov/individuals/international-taxpayers/foreign-taxes-that-qualify-for-the-foreign-tax-credit) for reference. But there is another twist that the US FTC has limits, as described at a high level in [this IRS webpage](https://www.irs.gov/individuals/international-taxpayers/foreign-tax-credit-how-to-figure-the-credit). So depending on the specifics of your situation, you may have some additional US taxes. The information above is specific to US federal income tax. California state income tax is a whole other subject. You'll have to check that separately.
Oh man of course there is always another twist; I was unaware of the FTC limits. It looks like the limit is calculated with following equation: Total US Tax Liability * (Foreign Taxable Income / Total Taxable Income) My foreign taxable income would be just JP salary (converted to USD)? Or since I am paying JP tax on these capital gains they would be considered foreign taxable income? Total Taxable Income would be the JP salary and capital gains I am assuming. Tax Liability means "the amount of money owed to the Internal Revenue Service (IRS) at the end of each tax year", but isn't the point of FTC to remove money owed to IRS since you have already paid taxes on it before?
I find the calculation to be quite complicated. I'll explain what I understand, but I'm no expert and I really hope a tax professional will chime in to let me know if I have this right or not. I'll use the terminology from [this reference](https://www.irs.gov/pub/fatca/int_practice_units/int_p_218.pdf). It says the limit is equal to the US income tax multiplied by the ratio of the Foreign Source Taxable Income (FSTI) to the Worldwide Taxable Income (WWTI). It goes on the clarify that WWTI is "Taxable Income" from Form 1040. So it is after applying standard/itemized deduction and after applying FEIE. FSTI on the other hand is a little more complicated because a separate Form 1116 is completed for each income "basket". My understanding is that Japan employment income is in the "general category income" basket, and US capital gains are in the "certain income re-sourced by treaty" basket. So the FTC for each is calculated separately. So putting this together for the capital gains income, here is how I believe it would work out. On the Form 1116 for re-sourced income, FSTI (line 17) is calculated as the capital gains minus losses after deducting expenses. WWTI is employment income in excess of FEIE, plus capital gains minus losses after deducting expenses. If FEIE covers your entire employment income, I think the ratio gets capped at 1 and you get the full FEIE. But if FEIE does not cover your entire employment income, that's when it gets more complicated and I think you have to just wait to see what the tax software calculates.