Foreign Currency Gains on a Mortgage: An Often-Overlooked Tax Issue

When you take out a mortgage in a foreign currency to buy property abroad, and the foreign currency later weakens against the US dollar, you have effectively paid back less in dollar terms than you borrowed, and the IRS treats this as a foreign currency gain. Under Section 988, that currency gain on a personal foreign-currency mortgage is taxable as ordinary income in the year the gain is realized, which for most mortgages means the year you pay off or refinance the loan. This can create a US tax bill even if you made no profit on the property itself: if you bought a house in euros with a euro mortgage and the euro fell significantly during your ownership, you could owe US tax on the currency gain when you pay off the loan, even if the property's euro value never moved. The rules apply to any foreign-currency denominated loan, not just mortgages, and they routinely catch US expats off guard when they sell a foreign property or pay off a local loan. Tracking the exchange rate at the time of each principal payment and at the time of any loan payoff is important for calculating this gain correctly.