Q: I am an American citizen and I have money in a CD in India that will mature in 10 years. Do I have to pay taxes in the U.S. in a given year, even if the value of my account goes down because of currency changes?
A: This is a very specialized tax question, so you would probably wise to consult with a qualified tax accountant for an answer that is completely suited to your particular situation. However, it is possible to outline the major issues involved.
First of all, it appears that in terms of reporting, there are three standards that may apply:
- Foreign holdings of more than $10,000 must be reported annually to the IRS via the Financial Crimes Enforcement Network's Form 114, Report of Foreign Bank and Financial Accounts.
- If the value of your foreign holdings exceeds $50,000 at the end of the tax year, or was above $75,000 at any point during the tax year, you will probably have to report those holdings by attaching IRS Form 8938 to your tax return.
- Regardless of whether you have to report the holdings pursuant to either of the above requirements, if you are paying U.S. taxes you will probably be obligated to report any income from those holdings on your return.
Income earned in a foreign currency must be translated to U.S. dollars for tax reporting purposes. So, if the Indian currency goes down, your reportable CD interest could be reduced by the currency change. However, the change in principal value of the CD would probably not be reportable as a loss until you cash in the CD and convert it back to U.S. dollars.
Currency translation is often the fatal flaw of investing in foreign CDs. The best CD rates, along with the highest rates on savings accounts or money market accounts, can often be found in countries with weak currencies. This is because those countries often pump up their interest rates in an attempt to attract investment to shore up the currency, and also because a weak currency is generally inflationary, which causes interest rates to rise naturally.
To a U.S. investor, this means the interest you earn may be devalued by currency translation, and meanwhile, the principal value of the account would also be devalued by that same currency translation. Keep in mind too that foreign bank accounts are not covered by FDIC insurance protection, so their rates are really not directly comparable with U.S. rates.
Adding insult to injury, it appears that you would have to pay tax on the interest earned from a foreign CD (adjusted for currency translation), but this would not be offset by losses to the principal until you cash in your CD.
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