Publication 514
taxmap/pubs/p514-005.htm#en_us_publink1000224482As already indicated, you can claim a foreign tax credit only for foreign taxes on income, war profits, or excess profits, or taxes in lieu of those taxes. In addition, there is a limit on the amount of the credit that you can claim. You figure this limit and your credit on Form 1116. Your credit is the amount of foreign tax you paid or accrued or, if smaller, the limit.
If you have foreign taxes available for credit but you cannot use them because of the limit, you may be able to carry them back 1 tax year and forward to the next 10 tax years. See
Carryback and Carryover, later.
Also, certain tax treaties have special rules that you must consider when figuring your foreign tax credit. See
Tax Treaties,
later.
taxmap/pubs/p514-005.htm#en_us_publink1000224483You will not be subject to this limit and will be able to claim the credit without using Form 1116 if the following requirements are met.
- Your only foreign source gross income for the tax year is passive category income. Passive category income is defined later under
Separate Limit Income. However, for purposes of this rule, high taxed income and export financing interest are also passive category income.
- Your qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint
return).
- All of your gross foreign income and the foreign taxes are reported to you on a payee statement (such as a Form 1099-DIV or
1099-INT).
- You elect this procedure for the tax year.
If you make this election, you cannot carry back or carry over any unused foreign tax to or from this tax
year.
 | This election exempts you only from the limit figured on Form 1116 and not from the other requirements described in this publication. For example, the election does not exempt you from the requirements discussed earlier under
What Foreign Taxes Qualify for the Credit. |
taxmap/pubs/p514-005.htm#en_us_publink1000224485Your foreign tax credit cannot be more than your total U.S. tax liability (Form 1040, line 44) multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The denominator is your total taxable income from U.S. and foreign
sources.
To determine the limit, you must separate your foreign source income into categories, as discussed under
Separate Limit Income
next. The limit treats all foreign income and expenses in each separate category
as a single unit and limits the credit to the U.S. income tax on the taxable
income in that category from all sources outside the United States.
taxmap/pubs/p514-005.htm#en_us_publink1000224486You must figure the limit on a separate Form 1116 for each of the following categories of
income.
- Passive category income.
- General category income.
- Section 901(j) income.
- Certain income re-sourced by treaty.
- Any lump sum distribution from an employer benefit plan for which the special averaging treatment is used to determine your tax.
In figuring your separate limits, you must combine the income (and losses) in each category from all foreign sources, and then apply the limit.
taxmap/pubs/p514-005.htm#en_us_publink1000224487As a U.S. shareholder, certain income that you receive or accrue from a controlled foreign corporation (CFC) is treated as separate limit income. You are considered a U.S. shareholder in a CFC if you own 10% or more of the total voting power of all classes of the corporation's voting stock.
In most cases, subpart F inclusions, interest, rents, and royalties from a CFC are treated as separate limit income if they are attributable to the separate limit income of the CFC. A dividend paid or accrued out of the earnings and profits of a CFC is treated as separate limit income in the same proportion that the part of earnings and profits attributable to income in the separate category bears to the total earnings and profits of the CFC. For more information, see section 904(d)(3) of the Internal Revenue Code and Regulations section
1.904-5.
taxmap/pubs/p514-005.htm#en_us_publink1000224488In most cases, a partner's distributive share of partnership income is treated as separate limit income if it is from the separate limit income of the partnership. However, if the partner owns less than a 10% interest in the partnership, the income is treated as passive income in most cases. For more information, see Regulations section 1.904-5(h).
taxmap/pubs/p514-005.htm#en_us_publink1000224489Passive category income consists of passive income and specified passive category
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224490Except as described earlier under
Income from controlled foreign corporations and
Partnership distributive share, passive income generally includes the following.
- Dividends.
- Interest.
- Rents.
- Royalties.
- Annuities.
- Net gain from the sale of non-income-producing investment property or property that generates passive
income.
- Net gain from commodities transactions, except for hedging and active business gains or losses of producers, processors, merchants, or handlers of
commodities.
- Amounts you must include as foreign personal holding company income under section 551(a) or 951(a) of the Internal Revenue
Code.
- Amounts includible in income under section 1293 of the Internal Revenue Code (relating to certain passive foreign investment
companies).
If you receive foreign source distributions from a mutual fund or other regulated investment company that elects to pass through to you the foreign tax credit, in most cases the income is considered passive. The mutual fund will provide you with a Form 1099-DIV or substitute statement showing the amount of foreign taxes it elected to pass through to you.
taxmap/pubs/p514-005.htm#en_us_publink1000224491Passive income does not include any of the following.
- Gains or losses from the sale of inventory property or property held mainly for sale to customers in the ordinary course of your trade or
business.
- Export financing interest.
- High-taxed income.
- Active business rents and royalties.
- Any income that is defined in another separate limit category.
This is interest derived from financing the sale or other disposition of property for use outside the United States
if:
- The property is manufactured, produced, grown, or extracted in the United States by you or a related person,
and
- 50% or less of the fair market value of the property is due to imports into the United
States.
This is passive income subject to foreign taxes that are higher than the highest U.S. tax rate that can be imposed on the income. The high-taxed income and the taxes imposed on it are moved from passive category income into general category income. See Regulations section 1.904-4(c) for more information.
taxmap/pubs/p514-005.htm#en_us_publink1000224494Specified passive income consists of:
- Dividends from a DISC (domestic international sales corporation) or former DISC to the extent the dividends are treated as foreign source income,
and
- Distributions from a former FSC (foreign sales corporation) out of earnings and profits that are attributable to:
- Foreign trade income, or
- Interest and carrying charges derived from a transaction that results in foreign trade
income.
General category income includes income from sources outside the United States that is not passive category income or does not fall into one of the other separate limit categories discussed later. In most cases, it includes active business income and wages, salaries, and overseas allowances of an individual as an employee. General category income includes high-taxed income that would otherwise be passive income. See
High-taxed income, earlier, under
What is not passive income.In general, financial services income is treated as general category income if it is derived by a financial services entity. You are a financial services entity if you are predominantly engaged in the active conduct of a banking, insurance, financing, or similar business for any taxable year. In most cases, the financial services income of a financial services entity includes income derived in the active conduct of a banking, financing, insurance or similar business. Financial services income of a financial services entity also includes passive income and certain incidental
income.
If you qualify as a financial services entity because you treat certain items of income as active financing income under Regulations section 1.904-4(e)(2)(i)(Y), you must show the type and amount of each item on an attachment to Form
1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224497This is income earned from activities conducted in sanctioned countries. Income derived from each sanctioned country is subject to a separate foreign tax credit limitation. Therefore, you must use a separate Form 1116 for income earned from each such country. See
Taxes Imposed By Sanctioned Countries (Section 901(j) Income) under
Taxes for Which You Can Only Take an Itemized Deduction, earlier.
If a sourcing rule in an applicable income tax treaty treats U.S. source income as foreign source, and you elect to apply the treaty, the income will be treated as foreign
source.
You must compute a separate foreign tax credit limitation for any such income for which you claim benefits under a treaty, using a separate Form 1116 for each amount of re-sourced income from a treaty country. See sections 865(h), 904(d)(6), and 904(h)(10) and the regulations under those sections (including Regulation section 1.904-5(m)(7)) for any grouping rules and exceptions.
See
Tax Treaties, later, for further information regarding income re-sourced by
treaty.
If you receive a foreign source lump-sum distribution (LSD) from a retirement plan, and you figure the tax on it using the special averaging treatment for LSDs, you must make a special computation. Follow the Form 1116 instructions and complete the worksheet in those instructions to determine your foreign tax credit on the
LSD.
 | The special averaging treatment for LSDs is elected by filing Form 4972, Tax on Lump-Sum
Distributions. |
taxmap/pubs/p514-005.htm#en_us_publink1000224501Solely for purposes of allocating foreign taxes to separate limit income categories, those separate limit categories include any U.S. source income that is taxed by the foreign country or U.S.
possession.
If you paid or accrued foreign income tax for a tax year on income in more than one separate limit income category, allocate the tax to the income category to which the tax specifically relates. If the tax is not specifically related to any one category, you must allocate the tax to each category of income.
You do this by multiplying the foreign income tax related to more than one category by a fraction. The numerator of the fraction is the net income taxed by the foreign country in a separate category. The denominator is the total net income.
You figure net income by deducting from the gross income in each category and from the total gross income taxed by the foreign country or U.S. possession any expenses, losses, and other deductions definitely related to them under the laws of the foreign country or U.S. possession. If the expenses, losses, and other deductions are not definitely related to a category of income under foreign law, they are apportioned under the principles of the foreign law. If the foreign law does not provide for apportionment, use the principles covered in the U.S. Internal Revenue Code.
taxmap/pubs/p514-005.htm#en_us_publink1000224502You paid foreign income taxes of $3,200 to Country A on wages of $80,000 and interest income of $3,000. These were the only items of income on your foreign return. You also have deductions of $4,400 that, under foreign law, are not definitely related to either the wages or interest income. Your total net income is $78,600
($83,000–$4,400).
Because the foreign tax is not specifically for either item of income, you must allocate the tax between the wages and the interest under the tax laws of Country A. For purposes of this example, assume that the laws of Country A do this in a manner similar to the U.S. Internal Revenue Code. First figure the net income in each category by allocating those expenses that are not definitely related to either category of
income.
You figure the expenses allocable to wages (general category income) as
follows.
$80,000 (wages)
$83,000 (total income)
| × | $4,400 | = | $4,241 |
| The net wages are $75,759 ($80,000 − $4,241). |
| | | | | |
You figure the expenses allocable to interest (passive category income) as
follows.
$3,000 (interest)
$83,000 (total income)
| × | $4,400 | = | $159 |
| The net interest is $2,841 ($3,000 − $159). |
| | | | | |
Then, to figure the foreign tax on the wages, you multiply the total foreign income tax by the following
fraction.
$75,759 (net wages)
$78,600 (total net income)
| × | $3,200 | = | $3,084 |
| | | | | |
| | | | | |
You figure the foreign tax on the interest income as follows.
$2,841 (net interest)
$78,600 (total net income)
| × | $3,200 | = | $116 |
If foreign taxes were paid or accrued on your behalf by a partnership or an S corporation, you will figure your credit using certain information from the Schedule K-1 you received from the partnership or S corporation. If you received a 2012 Schedule K-1 from a partnership or an S corporation that includes foreign tax information, see your Form 1116 instructions for how to report that information.
taxmap/pubs/p514-005.htm#en_us_publink1000224508Before you can determine the limit on your credit, you must first figure your total taxable income from all sources before the deduction for personal exemptions. This is the amount shown on line 41 of Form 1040 or line 39 of Form 1040NR. Then for each category of income, you must figure your taxable income from sources outside the United States.
Before you can figure your taxable income in each category from sources outside the United States, you must first determine whether your gross income in each category is from U.S. sources or foreign sources. Some of the general rules for figuring the source of income are outlined in
Table 2.
In most cases, the rules for determining whether income is from sources in a U.S. possession are the same as those for determining whether income is from U.S. sources. However, exceptions do apply. See Pub.
570 for more information.
If you are an employee and receive compensation for labor or personal services performed both inside and outside the United States, special rules apply in determining the source of the compensation. Compensation (other than certain fringe benefits) is sourced on a time basis. Certain fringe benefits (such as housing and education) are sourced on a geographical
basis.
Or, you may be permitted to use an alternative basis to determine the source of compensation. See
Alternative basis, later.
If you are self-employed, you determine the source of compensation for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. In many cases, the facts and circumstances will call for an apportionment on a time basis as explained
next.
taxmap/pubs/p514-005.htm#en_us_publink1000224511Use a time basis to figure your foreign source compensation (other than the fringe benefits discussed later). Do this by multiplying your total compensation (other than the fringe benefits discussed later) by the following fraction:
| | Number of days you performed services in the foreign country during the
year | |
| | Total number of days you performed services during the year | |
You can use a unit of time less than a day in the above fraction, if appropriate. The time period for which the compensation is made does not have to be a year. Instead, you can use another distinct, separate, and continuous time period if you can establish to the satisfaction of the IRS that this other period is more
appropriate.
taxmap/pubs/p514-005.htm#en_us_publink1000270973Table 2. Source of Income
| Item of Income | Factor Determining Source |
| Salaries, wages, other compensation | Where services performed |
| Business income: | |
| Personal services | Where services performed |
| Sale of inventory—purchased | Where sold |
| Sale of inventory—produced | Allocation |
| Interest | Residence of payer |
| Dividends | Whether a U.S. or foreign corporation* |
| Rents | Location of property |
| Royalties: | |
| Natural resources | Location of property |
| Patent, copyrights, etc. | Where property is used |
| Sale of real property | Location of property |
| Sale of personal property | Seller's tax home (but see
Determining the Source of Income From the Sales or Exchanges of Certain Personal
Property, later, for exceptions)
|
| Pension distributions attributable to contributions | Where services were performed that earned the pension |
| Investment earnings on pension contributions | Location of pension trust |
| Sale of natural resources | Allocation based on fair market value of product at export terminal. For more information, see Regulations section
1.863-1(b). |
* Exceptions include:
a) Dividends paid by a U.S. corporation are foreign source if the corporation elects the American Samoa Economic Development
Credit,
b) Part of a dividend paid by a foreign corporation is U.S. source if at least 25% of the corporation's gross income is effectively connected with a U.S. trade or business for the 3 tax years before the year in which the dividends are declared.
|
taxmap/pubs/p514-005.htm#en_us_publink1000224513Christina Brooks, a U.S. citizen, worked 240 days for a U.S. company during the tax year. She received $80,000 in compensation. None of it was for fringe benefits. Christina performed services in the United States for 60 days and performed services in the United Kingdom for 180 days. Using the time basis for determining the source of compensation, $60,000 ($80,000 ×
180/240) is her foreign source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224514Rob Waters, a U.S. citizen, is employed by a U.S. corporation. His principal place of work is in the United States. His annual salary is $100,000. None of it is for fringe benefits. During the first quarter of the year he worked entirely within the United States. On April 1, Rob was transferred to Singapore for the remainder of the year. Rob is able to establish that the first quarter of the year and the last 3 quarters of the year are two separate, distinct, and continuous periods of time. Accordingly, $25,000 of Rob's annual salary is attributable to the first quarter of the year (.25 × $100,000). All of it is U.S. source income because he worked entirely within the United States during that quarter. The remaining $75,000 is attributable to the last three quarters of the year. During those quarters, he worked 150 days in Singapore and 30 days in the United States. His periodic performance of services in the United States did not result in distinct, separate, and continuous periods of time. Of his $75,000 salary, $62,500 ($75,000 ×
150/180) is foreign source income for the year.
taxmap/pubs/p514-005.htm#en_us_publink1000224515In most cases, the source of multi-year compensation is determined on a time basis over the period to which the compensation is attributable. Multi-year compensation is compensation that is included in your income in one tax year but that is attributable to a period that includes two or more tax
years.
You determine the period to which the compensation is attributable based on the facts and circumstances of your case. For example, an amount of compensation that specifically relates to a period of time that includes several calendar years is attributable to the entire multi-year
period.
The amount of compensation treated as from foreign sources is figured by multiplying the total multi-year compensation by a fraction. The numerator of the fraction is the number of days (or unit of time less than a day, if appropriate) that you performed labor or personal services in the foreign country in connection with the project. The denominator of the fraction is the total number of days (or unit of time less than a day, if appropriate) that you performed labor or personal services in connection with the
project.
taxmap/pubs/p514-005.htm#en_us_publink1000224519Compensation you receive as an employee in the form of the following fringe benefits is sourced on a geographical basis.
- Housing.
- Education.
- Local transportation.
- Tax reimbursement.
- Hazardous or hardship duty pay.
- Moving expense reimbursement.
The amount of fringe benefits must be reasonable and you must substantiate them by adequate records or by sufficient evidence. Table 3 summarizes the factors used for determining the source of these fringe
benefits.
taxmap/pubs/p514-005.htm#en_us_publink1000224520Table 3. Source of Fringe Benefits
| Fringe Benefit | Factor Determining Source |
| Housing, education, and local transportation | Location of your principal place of work |
| Tax reimbursement | Location of the jurisdiction that imposed the tax for which you were
reimbursed |
| Hazardous or hardship duty pay | Location of the hazardous or hardship duty zone for which you received the
pay |
| Moving expense reimbursement | Location of your new principal place of work*
|
| *You can determine the source based on the location of your former principal place of work if you have sufficient evidence that such determination of source is more appropriate under the facts and circumstances of your case.
|
The source of a housing fringe benefit is determined based on the location of your principal place of work. A housing fringe benefit includes payments to or on your behalf (and your family if your family resides with you) only for the
following:
- Rent.
- Utilities (except telephone charges).
- Real and personal property insurance.
- Occupancy taxes not deductible under section 164 or 216(a).
- Nonrefundable fees for securing a leasehold.
- Rental of furniture and accessories.
- Household repairs.
- Residential parking.
- Fair rental value of housing provided in kind by your employer.
A housing fringe benefit does not include:
- Deductible interest and taxes (including deductible interest and taxes of a tenant-stockholder in a cooperative housing
corporation),
- The cost of buying property, including principal payments on a
mortgage,
- The cost of domestic labor (maids, gardeners, etc.),
- Pay television subscriptions,
- Improvements and other expenses that increase the value or appreciably prolong the life of
property,
- Purchased furniture or accessories,
- Depreciation or amortization of property or improvements,
- The value of meals or lodging that you exclude from gross income,
or
- The value of meals or lodging that you deduct as moving expenses.
The source of an education fringe benefit for the education expenses of your dependents is determined based on the location of your principal place of work. An education fringe benefit includes payments only for the following expenses for education at an elementary or secondary
school.
- Tuition, fees, academic tutoring, special needs services for a special needs student, books, supplies, and other
equipment.
- Room and board and uniforms that are required or provided by the school in connection with enrollment or
attendance.
The source of a local transportation fringe benefit is determined based on the location of your principal place of work. Your local transportation fringe benefit is the amount that you receive as compensation for your local transportation or that of your spouse or dependents at the location of your principal place of work. The amount treated as a local transportation fringe benefit is limited to actual expenses incurred for local transportation and the fair rental value of any employer-provided vehicle used predominantly by you or your spouse or dependents for local transportation. Actual expenses do not include the cost (including interest) of any vehicle purchased by you or on your
behalf.
taxmap/pubs/p514-005.htm#en_us_publink1000224526The source of a foreign tax reimbursement fringe benefit is determined based on the location of the jurisdiction that imposed the tax for which you are
reimbursed.
taxmap/pubs/p514-005.htm#en_us_publink1000224527The source of hazardous or hardship duty pay fringe benefit is determined based on the location of the hazardous or hardship duty zone for which the hazardous or hardship duty pay fringe benefit is paid. A hazardous or hardship duty zone is any place in a foreign country which meets either of the following
conditions.
- The zone is designated by the Secretary of State as a place where living conditions are extraordinarily difficult, notably unhealthy, or where excessive physical hardships exist, and for which a post differential of 15 percent or more would be provided under section 5925(b) of Title 5 of the U.S. Code to any officer or employee of the U.S. government at that
place.
- The zone is where civil insurrection, civil war, terrorism, or wartime conditions threaten physical harm or imminent danger to your health and
well-being.
Compensation is treated as a hazardous or hardship duty pay fringe benefit only if your employer provides the hazardous or hardship duty pay fringe benefit only to employees performing labor or personal services in a hazardous or hardship duty
zone.
The amount of compensation treated as a hazardous or hardship duty pay fringe benefit cannot exceed the maximum amount that the U.S. government would allow its officers or employees present at that
location.
taxmap/pubs/p514-005.htm#en_us_publink1000224528In most cases, the source of a moving expense reimbursement is based on the location of your new principal place of work. However, the source is determined based on the location of your former principal place of work if you have sufficient evidence that such determination of source is more appropriate under the facts and circumstances of your case. Sufficient evidence generally requires an agreement between you and your employer in most cases, or a written statement of company policy, which is reduced to writing before the move and which is entered into or established to induce you or other employees to move to another country. The written statement or agreement must state that your employer will reimburse you for moving expenses that you incur to return to your former principal place of work regardless of whether you continue to work for your employer after returning to that location. It may contain certain conditions upon which the right to reimbursement is determined as long as those conditions set forth standards that are definitely ascertainable and can only be fulfilled prior to, or through completion of, your return move to your former principal place of
work.
taxmap/pubs/p514-005.htm#en_us_publink1000224529If you are an employee, you can determine the source of your compensation under an alternative basis if you establish to the satisfaction of the IRS that, under the facts and circumstances of your case, the alternative basis more properly determines the source of your compensation than the time or geographical basis. If you use an alternative basis, you must keep (and have available for inspection) records to document why the alternative basis more properly determines the source of your compensation. Also, if your total compensation from all sources was $250,000 or more, you must check the box on Form 1116, line 1b, and attach a written statement to your tax return that sets forth all of the
following:
- Your name and social security number (written across the top of the
statement),
- The specific compensation income, or the specific fringe benefit, for which you are using the alternative
basis,
- For each item in (2), the alternative basis of allocation of source
used,
- For each item in (2), a computation showing how the alternative allocation was computed,
and
- A comparison of the dollar amount of the U.S. compensation and foreign compensation sourced under both the alternative basis and the time or geographical basis discussed
earlier.
Transportation income is income from the use of a vessel or aircraft or for the performance of services directly related to the use of any vessel or aircraft. This is true whether the vessel or aircraft is owned, hired, or leased. The term "vessel or aircraft" includes any container used in connection with a vessel or
aircraft.
All income from transportation that begins and ends in the United States is treated as derived from sources in the United States. If the transportation begins or ends in the United States, 50% of the transportation income is treated as derived from sources in the United States.
For transportation income from personal services, 50% of the income is U.S. source income if the transportation is between the United States and a U.S. possession. For nonresident aliens, this only applies to income derived from, or in connection with, an
aircraft.
taxmap/pubs/p514-005.htm#en_us_publink1000224530In most cases, if personal property is sold by a U.S. resident, the gain or loss from the sale is treated as U.S. source. If personal property is sold by a nonresident, the gain or loss is treated as foreign source.
This rule does not apply to the sale of inventory, intangible property, or depreciable property, or property sold through a foreign office or fixed place of business. The rules for these types of property are discussed
later.
taxmap/pubs/p514-005.htm#en_us_publink1000224531The term "U.S. resident," for this purpose, means a U.S. citizen or resident alien who does not have a tax home in a foreign country. The term also includes a nonresident alien who has a tax home in the United States. In most cases, your tax home is the general area of your main place of business, employment, or post of duty, regardless of where you maintain your family home. Your tax home is the place where you are permanently or indefinitely engaged to work as an employee or self-employed individual. If you do not have a regular or main place of business because of the nature of your work, then your tax home is the place where you regularly live. If you do not fit either of these categories, you are considered an itinerant and your tax home is wherever you work.
taxmap/pubs/p514-005.htm#en_us_publink1000224532A 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 tax had the sale resulted in a
gain.
taxmap/pubs/p514-005.htm#en_us_publink1000224533Income from the sale of inventory that you purchased is sourced where the property is sold. In most cases, this is where title to the property passes to the buyer.
Income from the sale of inventory that you produced in the United States and sold outside the United States (or vice versa) is sourced based on an allocation. For information on making the allocation, see Regulations section
1.863-3.
taxmap/pubs/p514-005.htm#en_us_publink1000224534Intangibles include patents, copyrights, trademarks, and goodwill. The gain from the sale of amortizable or depreciable intangible property, up to the previously allowable amortization or depreciation deductions, is sourced in the same way as the original deductions were sourced. This is the same as the source rule for gain from the sale of depreciable property. See
Depreciable property, next, for details on how to apply this rule.
Gain in excess of the amortization or depreciation deduction is sourced in the country where the property is used if the income from the sale is contingent on the productivity, use, or disposition of that property. If the income is not contingent on the productivity, use, or disposition of the property, the income is sourced according to the seller's tax home as discussed earlier. Payments for goodwill are sourced in the country where the goodwill was generated if the payments are not contingent on the productivity, use, or disposition of the property.
taxmap/pubs/p514-005.htm#en_us_publink1000224535The gain from the sale of depreciable personal property, up to the amount of the previously allowable depreciation, is sourced in the same way as the original deductions were sourced. Thus, to the extent the previous deductions for depreciation were allocable to U.S. source income, the gain is U.S. source. To the extent the depreciation deductions were allocable to foreign sources, the gain is foreign source income. Gain in excess of the depreciation deductions is sourced the same as inventory.
If personal property is used predominantly in the United States, treat the gain from the sale, up to the amount of the allowable depreciation deductions, entirely as U.S. source income.
If the property is used predominantly outside the United States, treat the gain, up to the amount of the depreciation deductions, entirely as foreign source income.
A loss is sourced in the same way as the depreciation deductions were sourced. However, if the property was used predominantly outside the United States, the entire loss reduces foreign source
income.
Depreciation includes amortization and any other allowable deduction for a capital expense that is treated as a deductible expense.
taxmap/pubs/p514-005.htm#en_us_publink1000224536In most cases, income earned by U.S. residents from the sale of personal property through an office or other fixed place of business outside the United States is treated as foreign source
if:
- The income from the sale is from the business operations located outside the United States,
and
- At least 10% of the income is paid as tax to the foreign country.
If less than 10% is paid as tax, the income is U.S. source.
This rule also applies to losses if the foreign country would have imposed a 10% or higher tax had the sale resulted in a
gain.
This rule does not apply to income sourced under the rules for inventory property, depreciable personal property, intangible property (when payments in consideration for the sale are contingent on the productivity, use, or disposition of the property), or goodwill.
taxmap/pubs/p514-005.htm#en_us_publink1000224537To figure your taxable income in each category from sources outside the United States, you first allocate to specific classes (kinds) of gross income the expenses, losses, and other deductions (including the deduction for foreign housing costs) that are definitely related to that income.
taxmap/pubs/p514-005.htm#en_us_publink1000224538A deduction is definitely related to a specific class of gross income if it is incurred
either:
- As a result of, or incident to, an activity from which that income is derived,
or
- In connection with property from which that income is derived.
You must determine which of the following classes of gross income your deductions are definitely related
to.
- Compensation for services, including wages, salaries, fees, and
commissions.
- Gross income from business.
- Gains from dealings in property.
- Interest.
- Rents.
- Royalties.
- Dividends.
- Alimony and separate maintenance.
- Annuities.
- Pensions.
- Income from life insurance and endowment contracts.
- Income from cancelled debts.
- Your share of partnership gross income.
- Income in respect of a decedent.
- Income from an estate or trust.
When you allocate deductions that are definitely related to one or more classes of gross income, you take exempt income into account for the allocation. However, do not take exempt income into account to apportion deductions that are not definitely related to a separate limit category.
taxmap/pubs/p514-005.htm#en_us_publink1000224541taxmap/pubs/p514-005.htm#en_us_publink1000224542If the class of gross income to which a deduction definitely relates includes
either:
- More than one separate limit category, or
- At least one separate limit category and U.S. source income,
you must apportion the definitely related deductions within that class of gross
income.
To apportion, you can use any method that reflects a reasonable relationship between the deduction and the income in each separate limit category. One acceptable method for many individuals is based on a comparison of the gross income in a class of income to the gross income in a separate limit income category.
Use the following formula to figure the amount of the definitely related deduction apportioned to the income in the separate limit
category:
Gross income in separate limit category
Total gross income in the class
| × | deduction |
Do not take exempt income into account when you apportion the deduction. However, income excluded under the foreign earned income or foreign housing exclusion is not considered exempt. You must, therefore, apportion deductions to that income.
In most cases, you apportion your interest expense on the basis of your assets. However, certain special rules apply. If you have gross foreign source income (including income that is excluded under the foreign earned income exclusion) of $5,000 or less, your interest expense can be allocated entirely to U.S. source
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224545Apportion interest incurred in a trade or business using the asset method based on your business assets.
Under the asset method, you apportion the interest expense to your separate limit categories based on the value of the assets that produced the income. You can value assets at fair market value, the tax book value, or the alternative book value. For more information about the asset method, see Temporary Regulations section
1.861-9T(g).
If you use the tax book value method, you can elect to change to the fair market value method at any time without IRS approval. If you elect to use the fair market value method, you must continue to use that method unless you have IRS approval to change
methods.
taxmap/pubs/p514-005.htm#en_us_publink1000224546Apportion this interest on the basis of your investment assets.
taxmap/pubs/p514-005.htm#en_us_publink1000224547Apportion interest incurred in a passive activity on the basis of your passive activity assets.
taxmap/pubs/p514-005.htm#en_us_publink1000224548General partners and limited partners with partnership interests of 10% or more must classify their distributive shares of partnership interest expense under the three categories listed above. They must apportion the interest expense according to the rules for those categories by taking into account their distributive share of partnership gross income or pro rata share of partnership assets. For special rules that may apply, see Regulations section
1.861-9T(e).
taxmap/pubs/p514-005.htm#en_us_publink1000224549This is your deductible home mortgage interest (including points and mortgage insurance premiums) from Schedule A (Form 1040). Apportion it under a gross income method, taking into account all income (including business, passive activity, and investment income), but excluding income that is exempt under the foreign earned income exclusion. The gross income method is based on a comparison of the gross income in a separate limit category with total gross
income.
The Instructions for Form 1116 have a worksheet for apportioning your deductible home mortgage interest
expense.
For this purpose, however, any qualified home (as defined in Publication 936) that is rented is considered a business asset for the period in which it is rented. You therefore apportion this interest under the rules for passive activity or business interest.
taxmap/pubs/p514-005.htm#en_us_publink1000224550You are operating a business as a sole proprietorship. Your business generates only U.S. source income. Your investment portfolio consists of several less-than-10% stock investments. You have stocks with an adjusted basis of $100,000. Some of your stocks (with an adjusted basis of $40,000) generate U.S. source income. Your other stocks (with an adjusted basis of $60,000) generate foreign passive income. You own your main home, which is subject to a mortgage of $120,000. Interest on this loan is home mortgage interest. You also have a bank loan in the amount of $40,000. The proceeds from the bank loan were divided equally between your business and your investment portfolio. Your gross income from your business is $50,000. Your investment portfolio generated $4,000 in U.S. source income and $6,000 in foreign source passive income. All of your debts bear interest at the annual rate of
10%.
The interest expense for your business is $2,000. It is apportioned on the basis of the business assets. All of your business assets generate U.S. source income; therefore, they are U.S. assets. This $2,000 is interest expense allocable to U.S. source
income.
The interest expense for your investments is also $2,000. It is apportioned on the basis of investment assets. $800 ($40,000/$100,000 × $2,000) of your investment interest is apportioned to U.S. source income and $1,200 ($60,000/$100,000 × $2,000) is apportioned to foreign source passive
income.
Your home mortgage interest expense is $12,000. It is apportioned on the basis of all your gross income. Your gross income is $60,000, $54,000 of which is U.S. source income and $6,000 of which is foreign source passive income. Thus, $1,200 ($6,000/$60,000 × $12,000) of the home mortgage interest is apportioned to foreign source passive
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224551State income taxes (and certain taxes measured by taxable income) are definitely related and allocable to the gross income on which the taxes are imposed. If state income tax is imposed in part on foreign source income, the part of your state tax imposed on the foreign source income is definitely related and allocable to foreign source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224552If the state does not specifically exempt foreign income from tax, the following rules
apply.
- If the total income taxed by the state is greater than the amount of U.S. source income for federal tax purposes, then the state tax is allocable to both U.S. source and foreign source income.
- If the total income taxed by the state is less than or equal to the U.S. source income for federal tax purposes, none of the state tax is allocable to foreign source
income.
If state law specifically exempts foreign income from tax, the state taxes are allocable to the U.S. source income.
taxmap/pubs/p514-005.htm#en_us_publink1000224554Your total income for federal tax purposes, before deducting state tax, is $100,000. Of this amount, $25,000 is foreign source income and $75,000 is U.S. source income. Your total income for state tax purposes is $90,000, on which you pay state income tax of $6,000. The state does not specifically exempt foreign source income from tax. The total state income of $90,000 is greater than the U.S. source income for federal tax purposes. Therefore, the $6,000 is definitely related and allocable to both U.S. and foreign source
income.
Assuming that $15,000 ($90,000 − $75,000) is the foreign source income taxed by the state, $1,000 of state income tax is apportioned to foreign source income, figured as
follows:
$15,000
$90,000
| × | $6,000 | = | $1,000 |
You must apportion to your foreign income in each separate limit category a fraction of your other deductions that are not definitely related to a specific class of gross income. If you itemize, these deductions are medical expenses, general sales taxes, and real estate taxes for your home. If you do not itemize, this is your standard deduction. You should also apportion any other deductions that are not definitely related to a specific class of income, including deductions shown on Form 1040, lines
23-35.
The numerator of the fraction is your gross foreign income in the separate limit category, and the denominator is your total gross income from all sources. For this purpose, gross income includes income that is excluded under the foreign earned income provisions but does not include any other exempt
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224559Do not take the deduction for personal exemptions, including exemptions for dependents, in figuring taxable income from sources outside the United States.
taxmap/pubs/p514-005.htm#en_us_publink1000224560Qualified dividends are the amounts you entered on Form 1040, line 9b, or Form 1040NR, line 10b. If you have any qualified dividends, you may be required to make adjustments to the amount of those qualified dividends before you take them into account on line 1a or line 18 of Form 1116. See
Foreign Qualified Dividends and Capital Gains (Losses)
in the Form 1116 instructions to determine the adjustments you may be required to make before taking foreign qualified dividends into account on line 1a of Form 1116. See the instructions for line 18 in the Form 1116 instructions to determine the adjustments you may be required to make before taking U.S. or foreign qualified dividends into account on line 18 of Form
1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224561If you have capital gains (including any capital gain distributions) or capital losses, you may have to make certain adjustments to those gains or losses before taking them into account on line 1a (gains), line 5 (losses), or line 18 (taxable income before subtracting exemptions) of Form
1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224562If you have foreign source capital gains or losses, you may be required to make certain adjustments to those foreign source capital gains or losses before you take them into account on line 1a or line 5 of Form 1116. Use the instructions under
Foreign Qualified Dividends and Capital Gains (Losses)
in the Instructions for Form 1116 to determine if you are required to make
adjustments. Also use the instructions under
Foreign Qualified Dividends and Capital Gains (Losses)
in the Instructions for Form 1116 to determine if you can use those instructions
to make adjustments or if you must use the instructions in this publication to
make adjustments.
taxmap/pubs/p514-005.htm#en_us_publink1000224563If you have U.S. or foreign source capital gains, you may be required to adjust the amount you enter on line 18 of Form 1116. Use the instructions for
Line 18
in the Instructions for Form 1116 to determine whether you are required to make
an adjustment and to determine the amount of the adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224564You may have to make the following adjustments to your foreign source capital gains and
losses.
- U.S. capital loss adjustment.
- Capital gain rate differential adjustment.
Before you make these adjustments, you must reduce your net capital gain by the amount of any gain you elected to include in investment income on line 4g of Form 4952, Investment Interest Expense Deduction. Your net capital gain is the excess of your net long-term capital gain for the year over any net short-term capital loss for the year. Foreign source gain you elected to include on line 4g of Form 4952 must be entered directly on line 1a of Form 1116 without
adjustment.
You must adjust the amount of your foreign source capital gains to the extent that your foreign source capital gain exceeds the amount of your worldwide capital gain (the "U.S. capital loss adjustment").
Your "foreign source capital gain" is the amount of your foreign source capital gains in excess of your foreign source capital losses. If your foreign source capital gains do not exceed your foreign source capital losses, you do not have a foreign source capital gain and you do not need to make the U.S. capital loss adjustment. See
Capital gain rate differential adjustment, later, for adjustments you must make to your foreign source capital gains or
losses.
Your "worldwide capital gain" is the amount of your worldwide (U.S. and foreign) capital gains in excess of your worldwide (U.S. and foreign) capital losses. If your worldwide capital losses equal or exceed your worldwide capital gains, your "worldwide capital gain" is
zero.
Your U.S. capital loss adjustment is the amount of your foreign source capital gain in excess of your worldwide capital gain. (If the amount of your foreign source capital gain does not exceed the amount of your worldwide capital gain, you do not have a U.S. capital loss adjustment.) See
Capital gain rate differential adjustment, later, for adjustments you must make to your foreign source capital gains or losses. If you have a U.S. capital loss adjustment, you must reduce your foreign source capital gains by the amount of the U.S. capital loss adjustment. To make this adjustment, you must allocate the total amount of the U.S. capital loss adjustment among your foreign source capital gains using the following
steps.
You must apportion the U.S. capital loss adjustment among your separate categories that have a net capital gain. A separate category has a net capital gain if the amount of foreign source capital gains in the separate category exceeds the amount of foreign source capital losses in the separate category. You must apportion the U.S. capital loss adjustment pro rata based on the amount of net capital gain in each separate
category.
taxmap/pubs/p514-005.htm#en_us_publink1000224567Alfie has a $300 foreign source capital gain that is passive category income, a $1,000 foreign source capital gain that is general category income, a $400 foreign source capital loss that is general category income, and a $150 U.S. source capital loss. He figures his net gains and U.S. capital loss adjustment as
follows.
| | Foreign source capital gain = $900
(($1,000 + $300) - $400)
Worldwide capital gain = $750
(($1,000 + $300) - ($400 + $150))
U.S. capital loss adjustment = $150
($900 - $750)
|
| | | |
Alfie must then apportion the U.S. capital loss adjustment ($150) between the
passive category income and the general category income based on the amount of
net capital gain in each separate category.
| | $50 apportioned to passive category income
($150 × $300/$900)
|
| | |
Alfie reduces his $300 net capital gain that is passive category income by $50 and includes the resulting $250 on line 1a of the Form 1116 for the passive category
income.
| | $100 apportioned to general category income
($150 × $600/$900)
|
Alfie reduces his $600 of net capital gain that is general category income by $100 and includes the resulting $500 on line 1a of the Form 1116 for the general category
income.
If you apportioned any amount of the total U.S. capital loss adjustment to a separate category with a net capital gain in more than one rate group, you must further apportion the U.S. capital loss adjustment among the rate groups in that separate category (separate category rate groups) that have a net capital
gain.
The
rate groups
are the 28% rate group, the 25% rate group, the 15% rate group, the 0% rate group, and the short-term rate group. The 28% rate group, the 25% rate group, the 15% rate group and the 0% rate group are "long-term" rate groups.
Table 4 explains the rate groups.
You must apportion the U.S. capital loss adjustment pro rata based on the amount of net capital gain in each separate category rate group. Your net capital gain in a separate category rate group is the amount of your foreign source capital gains in that separate category in the rate group in excess of your foreign source capital losses in that separate category in the rate group. If your foreign source capital losses exceed your foreign source capital gains, you have a net capital loss in the separate category rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224572Table 4. Rate Groups
| A capital gain or loss is in the... | | IF... | |
| 28% rate group
| | it is included on the 28%
Rate Gain Worksheet
in the instructions for Schedule D.
| |
| 25% rate group | | it is included on line 1 through line 13 of the
Unrecaptured Section 1250 Gain Worksheet
in the instructions for Schedule D.
| |
| 15% rate group | | it is a long-term capital gain that is not in the 28% or 25% rate group and is taxed at a 15% rate
or
it is a long-term capital loss that is not in the 28% or 25% rate group.
| |
| 0% rate group | | it is a long-term capital gain that is not in the 25% or 28% rate group and is taxed at a rate of
0%. | |
| Short-term rate group | | it is a short-term capital gain or loss.
| |
Dennis has a $300 U.S. source long-term capital loss. Dennis also has foreign
source capital gains and losses in the following categories.
| Income category | 28% rate | 15% rate | short-term |
| Passive
| $200 | | ($100) | | $100 | |
| General
| | | $700
($300)
| | | |
He figures his U.S. capital loss adjustment as follows.
| | Dennis' foreign source capital gain is $600.
(($200 + $700 + $100) - ($100 + $300))
Dennis' worldwide capital gain is $300.
(($200 + $700 + $100) - ($100 + $300 + $300))
Dennis' U.S. capital loss adjustment is $300.
($600 - $300)
|
| | | |
Dennis must apportion his $300 U.S. capital loss adjustment between passive category income and general category income based on the amount of net capital gain in each separate
category.
| | Dennis' net capital gain, passive category income is $200.
(($100 + $200) - $100)
Dennis apportions $100 to passive category income.
($300 × $200/$600)
|
| | | |
| | Dennis' net capital gain, general category income is $400.
($700 - $300)
Dennis apportions $200 to general category income.
($300 × $400/$600)
|
| | | |
Dennis has net capital gain in more than one rate group that is passive category income. Therefore, the $100 apportioned to passive category income must be further apportioned between the short-term rate group and the 28% rate group based on the amount of net capital gain in each rate
group.
| | Dennis apportions $33.33 to the short-term rate group.
($100 × $100/$300)
Dennis apportions $66.67 to the 28% rate group.
($100 × $200/$300)
|
| | | |
After the U.S. capital loss adjustment, Dennis has $100 of foreign source 15% capital loss that is passive category income, $66.67 of foreign source short-term capital gain that is passive category income, $133.33 of foreign source 28% gain that is passive category income, and $200 of foreign source 15% capital gain that is general category income, as shown in the following
table.
| Income category | 28% rate | 15% rate | short-term |
| Passive
| $200.00
-66.67
$133.33 | | ($100) | | $100.00
–33.33
$66.67 | |
| General
| | | $700.00
(300.00)
−200.00
$200.00
| | | |
After you have made your U.S. capital loss adjustment, you must make additional adjustments (capital gain rate differential adjustments) to your foreign source capital gains and
losses.
You must make adjustments to each separate category rate group that has a net capital gain or loss. See
Step 2 under
U.S. capital loss adjustment, earlier, for instructions on how to determine whether you have a net capital gain or loss in a separate category rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224581How you make the capital gain rate differential adjustment depends on whether you have a net capital gain or net capital loss in a separate category rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224582If you have a net capital gain in a separate category rate group, you must do the
following.
- First determine the amount of your net capital gain in each separate category rate group that must be
adjusted.
- Then make the capital gain rate differential adjustment. See
Capital gain rate differential adjustment for net capital
gains, later.
You must adjust the net capital gain in each separate category long-term rate group that remains after the U.S. capital loss adjustment. You must adjust the entire amount of that remaining net capital gain if you do not have a net long-term capital loss from U.S. sources or you do not have any short-term capital gains. If you have a net long-term capital loss from U.S. sources and you have any short-term capital gains, you only need to adjust a portion of the remaining net capital gain in each separate category long-term rate group. In that case, the portion you must adjust is limited to the portion of the remaining net capital gain in the separate category long-term rate group in excess of the U.S. long term loss adjustment amount (if any) allocated to that separate category long-term rate group. You have a net long-term capital loss from U.S. sources if your long-term capital losses from U.S. sources exceed your long-term capital gains from U.S.
sources.
The U.S. long-term loss adjustment amount is the excess of your net long-term capital loss from U.S. sources over the amount by which you reduced your long-term capital gains from foreign sources under
U.S. capital loss adjustment
earlier. If only one separate category long-term rate group has a net capital
gain after the U.S. capital loss adjustment, your U.S. long-term loss adjustment
amount is allocated to that separate category long-term rate group. If more than
one separate category long-term rate group has a net capital gain after the U.S.
capital loss adjustment, you must allocate the U.S. long-term loss adjustment
amount among the separate category long-term rate groups pro rata based on the
amount of the remaining net capital gain in each separate category long-term
rate group.
You must adjust the portion of your net capital gain in a separate category long-term rate group in excess of the U.S. long-term loss adjustment amount you allocated to that separate category long-term rate group. See the instructions, later, under
Capital gain rate differential adjustment for net capital gains.
The remaining portion of your net capital gain in the separate category
long-term rate group must be entered on line 1a of Form 1116 without adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224584Example 3.
(p18)
Mary has a $200 15% capital loss from U.S. sources, a $50 15% capital gain from U.S. sources, and a $200 short-term capital gain from U.S. sources. Mary also has a $300 28% capital gain and a $150 15% capital gain from foreign sources that are passive category
income.
Mary does not have a U.S. capital loss adjustment because her foreign source capital gain ($450) does not exceed her worldwide capital gain ($500).
Mary's net long-term capital loss from U.S. sources is $150 ($200 - $50). Her U.S. long-term loss adjustment amount is $150 ($150 - $0). Mary allocates the $150 between the 28% rate group and the 15% rate group as follows.
Mary allocates $100 ($150 x $300/$450) to the 28% rate group that is passive
category income. Therefore, $200 ($300 - $100) of her $300 28% capital gain must
be adjusted before it is included on line 1a. The remaining $100 of 28% capital
gain is included on line 1a without adjustment.
Mary allocates $50 ($150 x $150/$450) to the 15% rate group that is passive
category income. Therefore, only $100 ($150 - $50) of her $150 15% capital gain
must be adjusted before it is included on line 1a. The remaining $50 of 15%
capital gain is included on line 1a without adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224585
Adjust your net capital gain (or the applicable portion of your net capital
gain) in each separate category long-term rate group as follows.
- For each separate category that has a net capital gain in the 0% rate group, do not include the applicable amount on Form
1116.
- For each separate category that has a net capital gain in the 15% rate group, multiply the applicable amount of the net capital gain by
0.4286.
- For each separate category that has a net capital gain in the 25% rate group, multiply the applicable amount of the net capital gain by
0.7143.
- For each separate category that has a net capital gain in the 28% rate group, multiply the applicable amount of the foreign source net capital gain by
0.8.
Add each result to any net capital gain in the same long-term separate category rate group that you were not required to adjust and include the combined amounts on line 1a of the applicable Form
1116.
No adjustment is required if you have a net capital gain in a short-term rate group. Include the amount of net capital gain in any short-term rate group on line 1a of the applicable Form 1116 without
adjustment.
taxmap/pubs/p514-005.htm#en_us_publink1000224586Beth has $200 of capital gains in the 28% rate group that are general category income and no other items of capital gain or loss. Beth must adjust the capital gain before she includes it on line 1a as
follows.
Beth includes $160 of capital gain on line 1a of Form 1116 for the general category
income.
The facts are the same as
Example 3. Mary includes the following amounts of passive category income on line 1a of Form 1116 for passive category income.
| | Mary includes $260 of the 28% capital gain
($200 × 0.8) + $100
|
| | Mary includes $92.86 of the 15% capital gain ($100 × 0.4286) +
$50 |
The facts are the same as
Example 2. After making the U.S. capital loss adjustment, Dennis has the
following:
| Income category | 28% rate | 15% rate | short-term |
| Passive
| $133.33 | | ($100) | | $66.67 | |
| General
| | | $200 | | | |
Dennis now determines the amount of the remaining net capital gain in each separate category long-term rate group that must be
adjusted.
Dennis' net long-term capital loss from U.S. sources is $300. His U.S. long-term loss adjustment amount is $33.33 ($300 − $266.67). Dennis must allocate this amount between the $133.33 of net capital gain remaining in the 28% rate group that is passive category income and the $200 of net capital gain remaining in the 15% rate group that is general category
income.
Dennis allocates $13.33 ($33.33 × $133.33 ÷ $333.33) of the U.S. long-term loss adjustment to passive category income in the 28% rate group. Therefore, Dennis must adjust $120 ($133.33 − $13.33) of the $133.33 net capital gain remaining in the 28% rate group that is passive category income. Dennis includes $109.33 (($120 × 0.8) + 13.33) of 28% capital gain and $66.67 of short-term capital gain on line 1a of Form 1116 for passive category
income.
Dennis allocates $20 ($33.33 × $200 ÷ $333.33) to the 15% rate group for general category income. Therefore, Dennis must adjust $180 ($200 − $20) of the $200 net capital gain remaining in the 15% rate group that is general category income. Dennis includes $97.15 (($180 × 0.4286) + $20) of 15% capital gain on line 1a of Form 1116 for general category
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224593taxmap/pubs/p514-005.htm#en_us_publink1000224594Use the following ordering rules to determine the rate group of the capital gain offset by the net capital
loss.
Determinations under the following ordering rules are made after you have taken into account any U.S. capital loss adjustment. However, determinations under the following ordering rules do not take into account any capital gain rate differential adjustments that you made to any net capital gain in a separate category rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224595Net capital losses from each separate category rate group are netted against net capital gains in the same rate group in other separate
categories.
taxmap/pubs/p514-005.htm#en_us_publink1000224596U.S. source capital losses are netted against U.S. source capital gains in the same rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224597Net capital losses from each separate category rate group in excess of the amount netted against foreign source net capital gains in
Step 1
are netted against your remaining foreign source net capital gains and your U.S.
source net capital gains as follows.
- First, against U.S. source net capital gains in the same rate group,
and
- Next, against net capital gains in other rate groups (without regard to whether such net capital gains are U.S. or foreign source net capital gains) as
follows.
- A foreign source net capital loss in the short-term rate group is first netted against any net capital gain in the 28% rate group, then against any net capital gain in the 25% rate group, then against any net capital gain in the 15% rate group, and finally to offset capital gain net income in the 0% rate
group.
- A foreign source net capital loss in the 28% rate group is netted first against any net capital gain in the 25% rate group, then against any net capital gain in the 15% rate group, and finally to offset capital gain net income in the 0% rate
group.
- A foreign source net capital loss in the 15% rate group is netted first against any net capital gain in the 0% rate group, then any net capital gain in the 28% rate group, and finally against any net capital gain in the 25% rate
group.
The net capital losses in any separate category rate group are treated as coming pro rata from each separate category that contains a net capital loss in that rate group to the extent netted
against:
- Net capital gains in any other separate category under
Step 1,
- Any U.S. source net capital gain under
Step 3(1), or
- Net capital gains in any other rate group under
Step 3(2).
After you have determined the rate group of the capital gain offset by the net capital loss, you make the capital gain rate differential adjustment by doing the
following.
- To the extent a net capital loss in a separate category rate group offsets capital gain in the 0% rate group, multiply the net capital loss by
zero.
- To the extent a net capital loss in a separate category rate group offsets capital gain in the 15% rate group, multiply the capital loss by
0.4286.
- To the extent that a net capital loss in a separate category rate group offsets capital gain in the 25% rate group, multiply that amount of the net capital loss by
0.7143.
- To the extent that a net capital loss in a separate category rate group offsets capital gain in the 28% rate group, multiply that amount of the capital loss by
0.8.
Include the results on line 5 of the applicable Form 1116.
No adjustment is required to the extent a net capital loss offsets short-term capital gains. Thus, a net capital loss is included on line 5 of the applicable Form 1116 without adjustment to the extent the net capital loss offsets net capital gain in the short-term rate
group.
taxmap/pubs/p514-005.htm#en_us_publink1000224599The facts are the same as
Example 2. Dennis has a $100 foreign source 15% capital loss that is passive category income.
This loss is netted against the $200 foreign source 15% capital gain that is general category income according to
Step 1.
Dennis includes $42.86 of the capital loss on line 5 of the Form 1116 for general category
income.
Dawn has a $20 net capital loss in the 15% rate group that is passive category income, a $40 net capital loss in the 15% rate group that is general category income, a $50 U.S. source net capital gain in the 15% rate group, and a $50 net capital gain in the 28% rate group that is passive category income, as shown in the following
table.
| Income category | 28% rate | 15% rate |
Foreign
Passive
| $50 | ($20) |
Foreign
General
| | ($40) |
| U.S. Source | | $50 |
Of the total $60 of foreign source net capital losses in the 15% rate group, $50 is treated as offsetting the $50 U.S. source net capital gain in the 15% rate group. (See
Step 3(1).)
| | $16.67 of the $50 is treated as coming from passive category
income.
($50 × $20/$60)
$33.33 of the $50 is treated as coming from general category
income.
($50 × $40/$60)
|
The remaining $10 of foreign source net capital losses in the 15% rate group are treated as offsetting net capital gain in the 28% rate group. (See
Step 3(2)(c).)
| | $3.33 is treated as coming from passive category income.
($10 × $20/$60)
$6.67 is treated as coming from general category income.
($10 × $40/$60)
|
Dawn includes $9.80 of the capital loss in the amount she enters on line 5 of Form 1116 for passive category income.
| | This is $7.14
($16.67 × 0.4286)
plus $2.66
($3.33 × 0.8)
|
Dawn includes $19.63 of capital loss in the amount she enters on line 5 of Form 1116 for general category
income.
| | This is $14.29
($33.33 × 0.4286)
plus $5.34
($6.67 × 0.8)
|
Dawn also includes $40.00 ($50 × 0.8) of capital gain in the amount she
enters on line 1a of Form 1116 for passive category income.
You must allocate foreign losses for any taxable year and U.S. losses for any taxable year (to the extent such losses do not exceed the separate limitation incomes for such year) among incomes on a proportionate
basis.
taxmap/pubs/p514-005.htm#en_us_publink1000224608If you have a foreign loss when figuring your taxable income in a separate limit income category, and you have income in one or more of the other separate categories, you must first reduce the income in these other categories by the loss before reducing income from U.S. sources.
taxmap/pubs/p514-005.htm#en_us_publink1000224609taxmap/pubs/p514-005.htm#en_us_publink1000224610You have $10,000 of passive category income and incur a loss of $5,000 of general category income. You must use the $5,000 loss to offset $5,000 of passive category
income.
taxmap/pubs/p514-005.htm#en_us_publink1000224611You must allocate foreign losses among the separate limit income categories in the same proportion as each category's income bears to total foreign income.
taxmap/pubs/p514-005.htm#en_us_publink1000224612You have a $2,000 loss that is general category income, $3,000 of passive category income, and $2,000 of income re-sourced by treaty. You must allocate the $2,000 loss to the income in the other separate categories. 60% ($3,000/$5,000) of the $2,000 loss (or $1,200) reduces passive category income and 40% ($2,000/$5,000) or $800 reduces the income re-sourced by
treaty.
taxmap/pubs/p514-005.htm#en_us_publink1000224613If you have a loss remaining after reducing the income in other separate limit categories, use the remaining loss to reduce U.S. source income. For this purpose, the amount of your U.S. source income is your taxable income from U.S. sources increased by the amount of capital losses from U.S. sources that reduced foreign source capital gains as part of a U.S. capital loss adjustment. See
U.S. capital loss adjustment, earlier, under
Adjustments to Foreign Source Capital Gains and Losses.
When you use a foreign loss to offset U.S. source income, you must recapture the
loss as explained later under
Recapture of Prior Year Overall Foreign Loss Accounts.
You should allocate any net loss from sources in the United States among the different categories of foreign income
after allocating all foreign losses as described earlier, and
before any of the adjustments discussed later.
The amount of your net loss from sources in the United States is equal to the excess of (1) your foreign source taxable income in all of your separate categories in the aggregate, after taking into account any adjustments under
Qualified Dividends and
Adjustments to Foreign Source Capital Gains and Losses over (2) the amount of taxable income you enter on Form 1116, line
18.
If you have only losses in your separate limit categories, or if you have a loss remaining after allocating your foreign losses to other separate categories, you have an overall foreign loss. If you use this loss to offset U.S. source income (resulting in a reduction of your U.S. tax liability), you must recapture your loss in each succeeding year in which you have taxable income from foreign sources in the same separate limit category. You must recapture the overall loss regardless of whether you chose to claim the foreign tax credit for the loss year.
You recapture the loss by treating part of your taxable income from foreign sources in a later year as U.S. source income. In addition, if, in a later year, you sell or otherwise dispose of property used in your foreign trade or business, you may have to recognize gain and treat it as U.S. source income, even if the disposition would otherwise be nontaxable. See
Dispositions, later. The amount you treat as U.S. source income reduces the foreign source income, and therefore reduces the foreign tax credit limit.
You must establish separate accounts for each type of foreign loss that you sustain. The balances in these accounts are the overall foreign loss subject to recapture. Reduce these balances at the end of each tax year by the loss that you recaptured. You must attach a statement to your Form 1116 to report the balances (if any) in your overall foreign loss accounts.
taxmap/pubs/p514-005.htm#en_us_publink1000224616You have an overall foreign loss if your gross income from foreign sources for a tax year is less than the sum of your expenses, losses, or other deductions that you allocated and apportioned to foreign income under the rules explained earlier under
Determining Taxable Income From Sources Outside the United
States. But see
Losses not considered, later, for exceptions.
You are single and have gross dividend income of $10,000 from U.S. sources. You also have a greater-than-10% interest in a foreign partnership in which you materially participate. The partnership has a loss for the year, and your distributive share of the loss is $15,000. Your share of the partnership's gross income is $100,000, and your share of its expenses is $115,000. Your only foreign source income is your share of partnership income, which is general category income. You are a bona fide resident of a foreign country and you elect to exclude your foreign earned income. You exclude the maximum $95,100. You also have itemized deductions of $6,100 that are not definitely related to any item of
income.
In figuring your overall foreign loss for general category income for the year, you must allocate a ratable part of the $6,100 in itemized deductions to the foreign source income. You figure the ratable part of the $6,100 that is for foreign source income, based on gross income, as
follows:
$100,000 (Foreign gross income)
$110,000 (Total gross income)
| × | $6,100 | = | $5,545 |
| | | | | | |
Therefore, your overall foreign loss for the year is $6,280 figured as
follows:
| Foreign gross income | | $100,000 |
Less:
Foreign earned income
exclusion
| $95,100 | | |
Allowable definitely
related expenses
[($4,900/$100,000) ×
$115,000]
| 5,635 | | |
Ratable part of itemized
deductions
| 5,545 | | 106,280 |
| Overall foreign loss | | $ 6,280 |
You do not consider the following in figuring an overall foreign loss in a given
year.
- Net operating loss deduction.
- Foreign expropriation loss not compensated by insurance or other
reimbursement.
- Casualty or theft loss not compensated by insurance or other reimbursement.
If you have an overall foreign loss for any tax year and use the loss to offset U.S. source income, part of your foreign source taxable income (in the same separate limit category as the loss) for each succeeding year is treated as U.S. source taxable income. The part that is treated as U.S. source taxable income is the smaller of the
following.
- The total amount of maximum potential recapture in all overall foreign loss accounts. The maximum potential recapture in any account for a category is the lesser
of:
- The current year taxable income from foreign sources in that category (the amount from Form 1116, line 15, less any adjustment for allocation of foreign losses and U.S. losses for that category, discussed earlier),
or
- The balance in the overall foreign loss account for that
category.
- 50% (or more, if you choose) of your total taxable income from foreign
sources.
If the total foreign income subject to recharacterization is the amount described in
1
above, then for each separate category the recapture amount is the maximum
potential recapture amount for that category. If the total foreign income
subject to recharacterization is the amount described in
2
above, then for each separate category the recapture amount is computed by
multiplying the total recapture amount by the following fraction:
| | Maximum potential recapture amount for the overall foreign loss account in the separate
category | |
| | Total amount of maximum potential recapture in all overall foreign loss
accounts | |
During 2011 and 2012, you were single and a 20% general partner in a partnership that derived its income from Country X. You also received dividend income from U.S. sources during those
years.
For 2011, the partnership had a loss and your share was $20,000, consisting of $110,000 gross income less $130,000 expenses. Your net loss from the partnership was $3,109, after deducting the foreign earned income exclusion and definitely related allowable expenses. This loss is related to general category income. Your U.S. dividend income was $20,000. Your itemized deductions totaled $6,000 and were not definitely related to any item of income. In figuring your taxable income for 2011, you deducted your share of the partnership loss from Country X from your U.S. source
income.
During 2012, the partnership had net income from Country X. Your share of the net income was $70,000, consisting of $130,000 gross income less $60,000 expenses. Your net income from the partnership was $18,792, after deducting the foreign earned income exclusion and the definitely related allowable expenses. This is general category income. You also received dividend income of $20,000 from U.S. sources. Your itemized deductions were $6,000, which are not definitely related to any item of income. You paid income taxes of $4,000 to Country X on your share of the partnership
income.
When figuring your foreign tax credit for 2012, you must find the foreign source taxable income that you must treat as U.S. source income because of the foreign loss recapture
provisions.
You figure the foreign taxable income that you must recharacterize as
follows:
| A. | Determination of 2011 Overall Foreign Loss |
| 1) | Partnership loss from Country X | | $3,109 |
| 2) | Add: Part of itemized deductions
allocable to gross income from
Country X
| | |
$110,000
$130,000
| × | $6,000 | = | $5,077 |
| 3) | Overall foreign loss for 2011 | | $8,186 |
| B. | Amount of Recapture for 2012 |
| 1) | Balance for general category
income foreign loss account
| | $8,186 |
| 2) | Taxable general category income after allocation of foreign losses—General category
income | $18,792 | | |
| | Less: Itemized deductions
allocable to that income
[($130,000/$150,000)
× $6,000]
| 5,200 | | |
| | General category taxable
income less allocated
foreign losses ($13,592 − 0)
| | $13,592 |
| 3) | Total amount of maximum potential recapture in all foreign loss accounts (smaller of (1) or
(2)) | | $8,186 |
| 4) | Foreign source net income | $18,792 | | |
| | Less: Itemized deductions
allocable to foreign source
net income [($130,000/
$150,000) × $6,000]
| 5,200 | | $13,592 |
| 5) | 50% of foreign source taxable income subject to recharacterization | | $6,796 |
| 6) | Recapture for 2012 (smaller of
(3) or (5))
| | $6,796 |
The amount of the recapture is shown on line 16, Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224627If you want to make an election or change a prior election to recapture a greater part of the balance of an overall foreign loss account than is required (as discussed earlier), you must attach a statement to your Form 1116. If you change a prior year's election, you should file Form
1040X.
The statement you attach to Form 1116 must show:
- The percentage and amount of your foreign taxable income that you are treating as U.S. source income,
and
- The percentage and amount of the balance (both before and after the recapture) in the overall foreign loss account that you are recapturing.
You must recapture part (or all, if applicable) of an overall foreign loss in tax years in which you deduct, rather than credit, your foreign taxes. You recapture the lesser
of:
- The balance in the applicable overall foreign loss account,
or
- The foreign source taxable income of the same separate limit category that resulted in the overall foreign loss minus the foreign taxes imposed on that
income.
If you dispose of appreciated trade or business property used predominantly outside the United States, and that property generates foreign source taxable income of the same separate limit category that resulted in an overall foreign loss, the disposition is subject to the recapture rules. In most cases, you are considered to recognize foreign source taxable income in the same separate limit category as the overall foreign loss to the extent of the lesser
of:
This rule applies to a disposition whether or not you actually recognized gain on the disposition and irrespective of the source (U.S. or foreign) of any gain recognized on the
disposition.
In most cases, this rule also applies to a gain on the disposition of stock in a controlled foreign corporation (CFC) if you owned more than 50% (by vote or value) of the stock right before you disposed of it. See Internal Revenue Code section 904(f)(3)(D) for more
information.
All of the foreign source taxable income that you are considered to recognize under these rules is subject to recharacterization as U.S. source income in most cases. See Regulation section
1.904(f)-2(d).
If you actually recognized foreign source gain in the same separate limit category as the overall foreign loss on a disposition of property described earlier, you must reduce the foreign source taxable income in that separate limit category by the amount of gain you are required to recharacterize. If you recognized foreign source gain in a different separate limit category than the overall foreign loss on a disposition of property described earlier, you are required to reduce your foreign source taxable income in that separate limit category for gain that is considered foreign source taxable income in the overall foreign loss category and subject to recharacterization. If you did not otherwise recognize gain on a disposition of property described earlier, you must include in your U.S. source income the foreign source taxable income you are required to recognize and
recharacterize.
taxmap/pubs/p514-005.htm#en_us_publink1000224630Property is used predominantly outside the United States if it was located outside the United States more than 50% of the time during the 3-year period ending on the date of disposition. If you used the property fewer than 3 years, count the use during the period it was used in a trade or business.
taxmap/pubs/p514-005.htm#en_us_publink1000224631A disposition includes the following transactions.
- A sale, exchange, distribution, or gift of property.
- A transfer upon the foreclosure of a security interest (but not a mere transfer of title to a creditor or debtor upon creation or termination of a security
interest).
- An involuntary conversion.
- A contribution to a partnership, trust, or corporation.
- A transfer at death.
- Any other transfer of property whether or not gain or loss is normally recognized on the
transfer.
The character of the income (for example, as ordinary income or capital gain) recognized solely because of the disposition rules is the same as if you had sold or exchanged the property.
However, a disposition does not include either of the following:
- A disposition of property that is not a material factor in producing income. (This exception does not apply to the disposition of stock in a controlled foreign corporation (CFC) to which Internal Revenue Code section 904(f)(3)(D)
applies.)
- A transaction in which gross income is not realized.
If gain is recognized on a disposition solely because of an overall foreign loss account balance at the time of the disposition, the recipient of the property must increase its basis by the amount of gain deemed recognized. If the property was transferred by gift, its basis in the hands of the donor immediately prior to the gift is increased by the amount of gain deemed
recognized.
taxmap/pubs/p514-005.htm#en_us_publink1000224633If, in a prior tax year, you reduced your foreign taxable income in the separate limit category by a pro rata share of a loss from another category, you must recharacterize in 2012 all or part of any income you receive in 2012 in that loss category. If you have separate limitation loss accounts in the loss category relating to more than one other category and the total balances in those loss accounts exceed the income you receive in 2012 in the loss category, then income in the loss category is recharacterized as income in those other categories in proportion to the balances of the separate limitation loss accounts for those other categories. You recharacterize the income
by:
- Increasing foreign taxable income (adjusted by any of the other adjustments previously mentioned) for each of the separate categories (other than the loss category) previously reduced by any separate limitation loss,
and
- Decreasing foreign taxable income (adjusted by any of the other adjustments previously mentioned) for the loss category by the amount of recharacterized
income.
In 2011, you had a $2,000 loss that was general category income, $3,000 of passive category income, and $2,000 of income re-sourced by treaty. You had to allocate the $2,000 loss to the income in the other separate categories. 60% ($3,000 ÷ $5,000) of the $2,000 loss (or $1,200) reduced passive category income and 40% ($2,000 ÷ $5,000) or $800 reduced the income re-sourced by
treaty.
In 2012, you have $4,000 of passive category income, $1,000 of income re-sourced by treaty, and $5,000 of general category income. Because $1,200 of the general category loss was used to reduce your passive category income in 2011, $1,200 of the 2012 general category income of $5,000 must be recharacterized as passive category income. This makes the 2012 total passive category income $5,200 ($4,000 + $1,200). Similarly, because $800 of the general category loss was used to reduce your income re-sourced by treaty, $800 of the general category income must be recharacterized as income re-sourced by treaty. This makes the 2012 total of income re-sourced by treaty $1,800 ($1,000 + $800). The total general category income is $3,000 ($5,000 − $1,200 −
$800).
| If you dispose of appreciated property that generates, or would generate, gain in a separate limitation loss account, the disposition is subject to recapture rules similar to those applicable to overall foreign loss accounts. See Internal Revenue Code section
904(f)(5)(F). |
taxmap/pubs/p514-005.htm#en_us_publink1000224635If you have an overall domestic loss for any tax year beginning after 2006, you create, or increase the balance in, an overall domestic loss account and you must recharacterize a portion of your U.S. source taxable income as foreign source taxable income in succeeding years for purposes of the foreign tax
credit.
The part that is treated as foreign source taxable income for the tax year is the smaller
of:
- The total balance in your overall domestic loss account in each separate category (less amounts recaptured in earlier years),
or
- 50% of your U.S. source taxable income for the tax year.
You must establish and maintain separate overall domestic loss accounts for each separate category in which foreign source income is offset by the domestic loss. The balance in each overall domestic loss account is the amount of the overall domestic loss subject to recapture. The recharacterized income is allocated among and increases foreign source income in separate categories in proportion to the balances of the overall domestic loss accounts for those separate
categories.
For more information, see the Instructions for Form 1116.
taxmap/pubs/p514-005.htm#en_us_publink1000224636The United States is a party to tax treaties that are designed, in part, to prevent double taxation of the same income by the United States and the treaty country. Many treaties do this by allowing you to treat U.S. source income as foreign source income. Certain treaties have special rules you must consider when figuring your foreign tax credit if you are a U.S. citizen residing in the treaty country. These rules generally limit the amount of U.S. source income that is treated as foreign source income. The treaties that provide for this type of restriction include those with Australia, Austria, Bangladesh, Belgium, Bulgaria, Canada, Czech Republic, Denmark, Finland, France, Germany, Iceland, Ireland, Israel, Italy, Japan, Luxembourg, Malta, Mexico, the Netherlands, New Zealand, Portugal, Slovak Republic, Slovenia, South Africa, Spain, Sweden, Switzerland, and the United Kingdom. There is a
Worksheet
at the end of this publication to help you figure the additional credit that is
allowed by reason of these limited re-sourcing rules. But do not use this
worksheet to figure the additional credit under the treaties with Australia and
New Zealand. In addition, except as provided in regulations, the worksheet does
not apply for tax years beginning after August 10, 2010. The amount of income
re-sourced in the separate category, as described under
"Certain Income Re-Sourced By Treaty,"
earlier, must be computed in accordance with the applicable treaty provision.
 | You can get more information by writing to:
Internal Revenue Service
International Section
Philadelphia, PA 19255-0725
|
You can also contact the United States Tax Attaché at the U.S. Embassies in Beijing, London or Paris, or the U.S. consulate in Frankfurt, as appropriate, for
assistance.
taxmap/pubs/p514-005.htm#en_us_publink1000224638You may have to report certain information with your return if you claim a foreign tax credit under a treaty provision. For example, if a treaty provision allows you to take a foreign tax credit for a specific tax that is not allowed by the Internal Revenue Code, you must report this information with your return. To report the necessary information, use Form 8833, Treaty-Based Return Position Disclosure Under Section 6114 or
7701(b).
If you do not report this information, you may have to pay a penalty of $1,000.
| You do not have to file Form 8833 if you are claiming the additional foreign tax credit (discussed
previously). |
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