Japanese Income Tax Loophole Allowing Write-Offs for Overseas Property Investments to be Closed

The government and the Liberal Democratic Party (LDP) plan to bring an end to a rule that allows people living in Japan to lower their income tax by investing in overseas real estate. Under the current rule, you can lower your tax burden by writing off losses in an overseas investment property against your Japanese income tax. This is as reported by the Nikkei newspaper. This tax-saving measure is frequently used by wealthy people to reduce their tax burden, but has now been deemed to be unfair to tax payers who don’t have the means to invest in overseas properties.

The details of the new rule were reviewed by the LDP’s tax review committee and will be included as part of the FY2020 revision of the income tax code. Actual application of the revised rule will apply to income tax reported in FY2021.

A tax loophole for the wealthy

In Japan, there is a tax rule that allows you to depreciate over a four year period the cost of buying a wooden building at least 20 years old. The reason why people prefer buying real estate in the US is because the value of the building (i.e. the depreciable asset) in a real estate deal is high. In Japan, land (a non-depreciable asset) makes up the bulk of the value in a real estate deal, but in the US, the building is oftentimes worth 80 percent of the whole real estate deal.

Say, for example, in a 50 million JPY real estate deal, the building is worth 40 million JPY. Depreciated over four years, that is a 10 million per year tax shelter against the owner’s ordinary Japanese income. If you make 25 million JPY a year, you get to take 10 million JPY off the top, before tax, so you pay income and residence tax as if you made 15 million JPY that year.

The more expensive the property, the greater the tax savings, so it is an incentive for anyone who can afford it to buy the most expensive house(s) overseas they can.

Basically, people have been using the loophole as a reason to buy older houses in the US and UK as a tax shelter. The revision to the rule will no longer allow depreciation losses on overseas property.

According to a survey conducted by the Audit Bureau of the Kojimachi Tax Office in Tokyo, a total of 337 people have claimed more than 3.98 billion yen (37.5 million USD) in tax write-offs using this method.

Some real estate companies have used this tax rule as a way to solicit business from wealthy individuals, and it is expected that closing the loophole will have an impact on this part of the market.

Source: Nikkei newspaper, November 26, 2019

Lead photo: Houses in San Francisco, stock photo via Pixabay (royalty-free)

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