Foreign Tax Deduction vs Credit

Question

As I understand it, the Form 1116 Foreign Tax Credit is intended to allow you to avoid double taxation on foreign income. You are allowed a credit up to the amount of US tax that is due to the foreign income (calculated on that income minus a proportional allocation of some personal deductions), or the actual foreign tax, whichever is less.

My question has to do with a situation where there is no 1116 credit available, but it appears the tax can still be deducted on Schedule A.

1. I am a US citizen and have a rental property in the UK. Note that in the UK, real property is not depreciated.
2. In the UK the property had net income for 2015 and taxes were paid.
3. Due the effect of US depreciation, with regards to US tax laws the property had a net loss in 2015, which showed up on schedule E.
4. Because no US tax is assessed due to the foreign income, the form 1116 deduction is zero (but the taxes paid can be carried over).

There doesn't seem to be anything obvious in the rules that would prevent me from deducting the foreign taxes on Schedule A instead. You can do this without ever filling out form 1116 or deciding if there's any US tax due to the foreign income.

However, if you do this it appears you will be deducting part of the taxes twice, first when calculating the Schedule E loss, and then again on Schedule A

Is deducting the taxes on Schedule A a valid thing to do given the above situation?

I don't plan to do this because filing form 1116 anyway allows me to carry forward the unused credit, to be used when the property is sold, but I'm curious about the seeming double-dip deduction.

Answer 1

Since you don't have passive income - you cannot use passive tax credit. If you expect to sell the property within the next 10 years, you can accumulate the credit. Otherwise - it will be lost and you won't be able to take advantage of it.

That is the exact scenario where taking a deduction for foreign tax credit can be helpful. You can deduct it now (i.e.: treat it as an expense) instead of using a credit later (which may never happen if you don't sell the property before the credit expires). There's no double dipping here, as the foreign taxes paid - are in fact paid, and you are entitled for tax benefit. Deduction provides a lower tax benefit than credit. Deduction saves you only the marginal rate, while credit is dollar for dollar.

Keep in mind that if you chose to deduct - you deduct all foreign paid taxes. I.e.: you cannot choose to deduct passive income taxes, but credit earned income taxes. More info here.