US Investors in Dubai Property Have Unique Tax Reporting Hurdles

Dubai’s booming economy and real estate market are attracting people from all over the world, including Americans. Some are purchasing properties to live in, while others are purchasing properties purely for investment purposes. But they may be unfamiliar with the unique tax challenges posed by owning real estate abroad.

Americans should know that because they’re US citizens, they’re liable for US taxes on their worldwide income no matter where they reside. As such, they must report and pay tax on all income from foreign real estate and are liable for gift taxes should they gift foreign real estate. Additionally, foreign real estate is included in their taxable estate should they die owning it.

Luckily for US citizens investing in the United Arab Emirates, they only need to worry about US taxes because the UAE doesn’t levy personal income, gift, or estate taxes.

Those using their UAE property as a residence generally can deduct interest on mortgages up to $750,000, and mortgage points also are generally deductible. While property taxes on foreign properties are deductible, they aren’t relevant here, because the UAE doesn’t levy any.

Those renting out their UAE properties must report rental income received, but they can deduct ordinary and necessary expenses directly related to the production of rental income. This generally includes but isn’t limited to: repairs and maintenance, property management and leasing fees, utilities, insurance, professional fees, and depreciation, although recovery periods vary.

Like with US properties, US taxpayers can depreciate foreign properties; meaning they can deduct a portion of the value of the building each year as an expense. While US residential properties are depreciable over 27.5 years, foreign properties are depreciable line over 30 years. For commercial real estate, it’s 39 and 40 years, respectively.

Additionally, US citizens who own rental property in the UAE can deduct their ordinary and necessary travel expenses to the UAE if they’re directly related to the production of rental income. Travel generally would be deductible if it’s to meet with property managers, inspect repairs, oversee renovations, resolve tenant issues, or deal with legal matters. Deductible expenses include flights, lodging, and ground transportation.

As with selling US property, capital gains are subject to tax. Short-term capital gains are taxed as ordinary income, while long-term capital gains are subject to the lower long-term capital gains tax rates. However, fluctuations in exchange rates can affect capital gains and losses.

When foreign real estate is bought and sold in a non-US currency, the gain or loss on disposition comprises both the change in the property’s value and the movement of the US dollar against that currency.

If the property is subject to a foreign currency denominated mortgage, the currency gain or loss on the repayment of the mortgage is considered a separate transaction under Section 988 of the Internal Revenue Code. Any gain or loss under Section 988 is taxed as ordinary gain or loss rather than capital; that is, any currency gain would taxed at ordinary income tax rater rather than long-term capital gains tax rates.

US citizens investing in the UAE don’t need to worry about currency gain or loss because the dirham, the UAE’s local currency, is pegged to the US dollar.

One thing I’ve always found interesting is that the ownership of foreign real estate, including UAE real estate, isn’t reportable to the IRS. The IRS requires the reporting of almost every foreign asset on one of their many international information returns, but not foreign real estate. The income associated with it must be reported, but not the real estate itself.

That said, most owners of UAE real estate have a UAE bank account to pay expenses for their property and deposit income from it. Depending on the balance of their account during the year, it may need to be reported on Form 8938 and/or an FBAR.

Any gift of UAE real estate by a US person will be subject to US gift tax, unless it’s below the annual or lifetime exemption amount. Even if no gift tax is due, the donor likely will be required to file a gift tax return.

If a US person dies owning UAE real estate, it will be included in their US taxable estate. Whether estate tax is due will depend on whether their estate exceeds their estate tax exemption. If an estate tax is required to be, or should be, filed depends on several factors that are beyond the scope of this article.

Estate planning for UAE assets shouldn’t be ignored because the default method of estate distribution in the UAE is in accordance with Sharia law, which generally isn’t desirable for non-Muslims because it distributes assets according to strict heirship shares based on Sharia law.

Assuming that your UAE assets will pass onto your heirs under your non-UAE will is a mistake. While the UAE may recognize a non-UAE will, there is no guarantee. Even if it is recognized, assets will have to go through a lengthy and costly probate process.

Prudent non-Muslim investors should, at the very least, have a UAE will in place. While this would ensure UAE assets pass to heirs as desired, assets still would need to go through probate.

The best solution is often for US investors to own their UAE real estate through a local private foundation, much like a trust. This avoids probate and provides asset protection, privacy, and flexible estate planning. If properly structured, it’s UAE and US tax neutral, although US international information returns will need to be filed.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jimmy Sexton is founder and CEO of Esquire Group and chairman of the International Business Structuring Association (Middle East Chapter).

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