How are Unrealized Gains Taxed at Exit: What About Losses

How are Unrealized Gains Taxed at Exit: What About Losses

The MTM Exclusion Amount at Exit 

When a US Citizen or Long-Term Lawful Permanent Resident is ready to either relinquish their green card or renounce their US citizenship, they must go through the expatriation process. Some taxpayers who are considered covered expatriates may be required to pay an exit tax at the time they give up their US status.  There are various different categories of potential income that may be taxed at exit — such as mark-to-market, specified tax-deferred accounts, and ineligible deferred compensation. One common issue for taxpayers who are trying to prepare the Mark to market tax calculation is how losses are applied; when they are applied, and how losses impact the exclusion amount. Let’s take a brief look at the MTM Exclusion Amount at Exit.

Mark-to-Market Exclusion

For 2022, the exclusion amount for net unrealized gain on property is $767,000. That means that if you were in a situation in which you are considered a covered expatriate and you have less than $767,000 in unrealized gain on your assets ––  you may be able to avoid exit tax on your unrealized gain. Putting it into an example, let’s say Jeffrey is considered to be a long-term lawful permanent resident and meets one of the three tests to be a covered expatriate. In evaluating the different types of foreign and US assets he has, it turns out he has $1.7M in stock that has a cost basis of $1 million. The total unrealized again would be $700,000, which is taxable. But, because Jeffrey has $767,000 in exclusion available, he would not have any taxable income at exit — at least on the amount in the mark-to-market category.  The exclusion is not applicable to other types of income such as specified tax-deferred accounts or ineligible deferred compensation.

Losses and the Exclusion

Another common question is whether losses can zero out with gains and then apply the exclusion to the remaining gain. The answer is no —  since it can lead to double-dipping. There is a good example in the instructions from the IRS, which is reproduced below. The exclusion is parsed out for each asset, based on the amount of gain proportionately and in relation to the total amount of assets/gain. In other words, the taxpayer cannot zero-out the losses vs. gains and then apply the exclusion or cherry-pick which assets he wants to apply the gain exclusion to (because he would then just apply the exclusion to higher-taxed items, such as short-term capital gains and ordinary dividends). If a taxpayer has a gain asset and a loss asset, they are not zeroed out in order to apply the exclusion to the remaining gains. Instead, the exclusion is only applied to gain assets.

Unrealized Gain Example (From the IRS)

      • X, a covered expatriate, renounced his citizenship on Date 2. On Date 1, the day before X’s renunciation of his citizenship, X owned three assets, which he had owned for more than 1 year. Asset A is business property and assets B and C are personal property. As of Date 1, Asset A had an FMV of $2,000,000 and a basis of $200,000; Asset B had an FMV of $1,000,000 and a basis of $800,000; and Asset C had an FMV of $500,000 and a basis of $800,000. X must allocate the exclusion amount as follows:

        • Step 1: Determine the built-in gain or loss of each asset by subtracting the basis from the FMV of the asset on Date 1.

            • Asset A has a Basis of 200K and FMV of 2M

            • Asset B has a Basis of 800K and FMV of 1M

            • Asset C has a Basis of 800K and FMV of 300K (Loss Property)

        • Step 2: Allocate the exclusion amount to each of the gain properties by multiplying the exclusion amount ($767,000) by a ratio of the deemed gain attributable to each gain property over the total gain of all the gain properties deemed sold.

            • Asset A = $1.8M (Gain)/$2M (Total Asset Gain) * 767,000 (Exclusion) = 690,300

            • Asset B = $200K (Gain)/$2M (Total Asset Gain) * 767,000 (Exclusion) = 76,700

            • Asset C = Loss Property

        • Step 3Figure the final amount of deemed gain on each asset by subtracting the exclusion amount allocated to each asset.

            • Asset A = 1.8M (Gain) – 690,300 (Exclusion)  = $1,109,700

            • Asset B = 200K (Gain) – 76,700 (Exclusion)  = $123,300

Calculating Losses against Gains

When it comes time to calculate the exit tax, taxpayers are allowed to take losses — although there are some limitations that do apply.

As provided by the IRS:

Taxation Under Section 877A

      • Gains from deemed sales are taken into account without regard to other rules under the Code. Losses from deemed sales are taken into account to the extent otherwise allowed under the Code. However, section 1091 (relating to the disallowance of losses on wash sales of stock and securities) doesn’t apply. For 2022, the net gain that you must otherwise include in your income is reduced (but not below zero) by $767,000.

Reporting gain or loss

      • You must report and recognize the gain (or loss) of each property reported in Section C, line 2, column (a), on the relevant form or schedule of your Form 1040 or 1040-SR for the part of the year that includes the day before your expatriation date. The return to which you attach your form or schedule will depend on your status at the end of the year. See chapter 1 of Pub. 519 to determine which form you should file. The gain from column (e) or loss from column (d) attributable to each property is reported in the same manner as if the property had actually been sold. For example, gain recognized from the deemed sale of a rental property that has been depreciated is reported on Form 4797 as if it had been sold. Gain recognized from the deemed sale of personal property (such as stock or a personal residence) is reported on Form 8949 as if it had been sold. Capital gain retains its character as capital gain; ordinary gain retains its character as ordinary income.

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