The US foreign tax credit lets an American offset US income tax, dollar for dollar, with income tax already paid to a foreign country on the same income, and Form 1116 is where that credit gets computed. The credit is capped each year by a limitation formula (US tax multiplied by the ratio of foreign-source taxable income to total taxable income), calculated separately for each of seven income categories the IRS calls baskets.[IRS, Instructions for Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), 2026-07]
For Americans who own property abroad, the credit is the main defense against being taxed twice on the same rental income or capital gain. Our read: for a property owner with a real foreign tax bill, Form 1116 beats the foreign earned income exclusion in almost every configuration, because the exclusion only covers earned income and rent is not earned income. The exclusion still wins for salaried remote workers in low-tax countries.
What the credit is and who files Form 1116
The US taxes citizens and green-card holders on worldwide income wherever they live. Section 901 of the Internal Revenue Code softens that by crediting foreign income taxes against the US liability on the same income. Without the credit, an American landlord in Lisbon would pay Portuguese tax on the rent and then full US tax on the same rent. With it, the US collects only the excess of the US rate over the Portuguese rate.
Form 1116 is required for individuals, estates, and trusts claiming the credit, with one exception: a filer whose foreign taxes are 300 US dollars or less (600 on a joint return), all passive, and all on payee statements such as a 1099-DIV can claim the credit directly on Form 1040 without the limitation calculation.[IRS, Foreign Tax Credit: How to Figure the Credit, 2026-07] That suits an investor with a bit of dividend withholding, not a property owner: foreign rental tax is never on a 1099, and the election forfeits carryovers for that year.
The credit is elective each year. The alternative, deducting foreign taxes as an itemized deduction, is worth far less: at a 24% marginal rate, 5,000 dollars of foreign tax is worth 5,000 as a credit and roughly 1,200 as a deduction. The deduction only makes sense when the tax is not creditable.
Which foreign taxes are creditable
Only foreign income taxes (and taxes imposed in lieu of an income tax, such as flat withholding on gross rent or dividends) qualify. The tax must be a compulsory levy on income that the filer is legally liable for and has paid or accrued, with no available refund.[IRS, Publication 514, Foreign Tax Credit for Individuals, 2026-07]
Property buyers get caught here more than anyone: most of the taxes a foreign property generates are not income taxes.
| Foreign levy | Creditable on Form 1116? | Notes |
|---|---|---|
| Income tax on rent (e.g. Portugal’s Category F flat rate) | Yes | The core case the credit exists for |
| Withholding tax on dividends or interest | Yes | Treaty-rate amount only; excess over the treaty rate is refundable abroad, not creditable |
| Capital gains tax on a property sale | Yes | Credited in the year the gain is also US-taxable |
| Annual property tax (Portugal’s IMI, Spain’s IBI, Mexico’s predial) | No | A property tax, not an income tax; deductible as a rental expense on Schedule E instead |
| VAT / IVA on renovation work or fees | No | A consumption tax |
| Transfer tax and stamp duty at purchase | No | Added to the property’s cost basis instead |
| Taxes refunded or refundable abroad | No | Only the final, unrefundable amount counts |
Two more exclusions: taxes paid to countries under section 901(j) sanctions, and foreign tax on income excluded under the foreign earned income exclusion, which is stripped out on line 12 of Form 1116. That second rule drives the FTC-versus-FEIE decision below.[IRS, Instructions for Form 1116, line 12 reductions for taxes on excluded income, 2026-07]
The seven income baskets
Form 1116 is filed once per category of income. Since the 2017 tax act there are seven baskets: passive category income, general category income, foreign branch income, section 951A (GILTI) income, income re-sourced by treaty, section 901(j) country income, and lump-sum distributions.[IRS, Practice Unit: Categorization of Income and Taxes Into Proper Basket, 2026-07]
For an individual property owner, two baskets do nearly all the work. Rental income, dividends, interest, and most capital gains are passive category income. Foreign salary and self-employment earnings are general category income. The separation has teeth: an American with excess credits from Portuguese rental tax (passive basket) cannot use them against US tax on a German salary (general basket). Each basket runs its own limitation, carryovers, and Form 1116.
The limitation formula
The credit for each basket is capped at:
US tax before credits × (foreign-source taxable income in the basket ÷ total taxable income)
The cap equals the US tax attributable to the foreign income. Foreign tax above the cap cannot offset US tax on US-source income; it becomes an excess credit. Foreign tax below it means the filer pays the US the difference.
The catch: “foreign-source taxable income” is computed under US rules, after US deductions, not the foreign country’s. The filer allocates deductions (including a share of the standard deduction and interest expense) against the foreign income before running the ratio. That recomputation is why the two countries’ taxable bases rarely match, and why excess credits are the normal condition for foreign landlords.
Carryback one year, carryforward ten
Excess credits are not lost. Under section 904(c), an unused foreign tax is carried back one year first (via an amended return, and the ordering is not optional), and whatever the prior year cannot absorb carries forward up to ten years, always within the same basket.[IRS, Publication 514, carryback and carryover of unused foreign tax, 2026-07]
The classic sequence for a foreign landlord: years of small excess credits accumulate in the passive basket, then the property sells, the US gain (off a depreciation-reduced basis) lands in the same basket, and the banked credits absorb part of the US bill. Credits in the GILTI basket are the exception, with no carryover at all, but that basket only touches owners of controlled foreign corporations.
The ten-year runway is a luxury the Canadian system does not offer: Canada’s non-business foreign tax credit, the one covering rent and gains, has no carryover in either direction, so the same stranded credit an American banks for a future sale simply dies on a Canadian return. The contrast is drawn in full on the Canadian foreign tax credit page.
FTC vs FEIE: credit or exclusion
The foreign earned income exclusion (Form 2555) is the other double-tax tool Americans abroad reach for, and the two mix badly. The FEIE lets a filer who passes either the bona fide residence test or the 330-day physical presence test exclude up to 130,000 US dollars of foreign earned income for 2025 (132,900 for 2026) from US tax.[IRS, Foreign Earned Income Exclusion, 2026-07]
| Foreign tax credit (Form 1116) | Foreign earned income exclusion (Form 2555) | |
|---|---|---|
| Income covered | Any foreign-source income: rent, gains, dividends, salary | Earned income only: wages, self-employment. Never rent, gains, or dividends |
| Cap | US tax attributable to the foreign income | 130,000 USD per person (2025) |
| Where it wins | Foreign tax rate at or above the US rate; property income | Low-tax or no-tax countries; salaried expats under the cap |
| Unused benefit | Carries back 1 year, forward 10 | None; unused exclusion vanishes |
| Residence test required | No | Yes (bona fide residence or 330 days) |
| Reversibility | Elect year by year | Revoking locks you out for 5 years without IRS consent |
Three mechanics decide most real cases. First, rental income is not earned income, so a pure property owner gets nothing from the FEIE. Second, the stacking rule: under section 911(f), excluded income still sets the rate, so the non-excluded income (including rental profit) is taxed at the marginal rates that would apply if the exclusion had not been taken.[IRS, Instructions for Form 2555, Foreign Earned Income Tax Worksheet, 2026-07] Third, foreign tax paid on excluded income is not creditable, so a filer in a high-tax country who elects the FEIE throws away credits that would have covered the US bill and banked a carryforward.
The disqualifier: an American earning a well-taxed salary in Portugal, Spain, or Italy is usually worse off electing the FEIE than crediting, because the foreign tax already exceeds the US tax and the exclusion burns the excess. The FEIE case is the Dubai or Panama salary with little or no local income tax. The revocation trap makes this a decision, not a habit: a filer who formally revokes the exclusion cannot claim it again for five tax years without an IRS ruling.[IRS, Revoking Your Choice to Exclude Foreign Earned Income, 2026-07]
Worked example: an American with Lisbon rental income
An American resident in the US owns a Lisbon apartment rented long-term at 2,000 euros a month, 24,000 a year. The US-Portugal income tax treaty (signed 1994, applied since January 1, 1996) lets Portugal tax the rent first as the situs country; the US taxes it too and credits the Portuguese tax.[IRS, Portugal Tax Treaty Documents, 2026-07]
Portuguese side. Long-term residential rent is Category F income, taxed at a flat 25% for a non-resident landlord after deducting documented expenses such as maintenance, condominium charges, and IMI.[Código do IRS, Article 72 (special rates on property income), Autoridade Tributária e Aduaneira, 2026-07] With 4,000 euros of deductible expenses, the Portuguese base is 20,000 and the tax 5,000 euros.
US side. The same rent goes on Schedule E, converted to dollars at the average annual rate. The US allows the operating expenses Portugal allowed, plus one deduction Portugal has no equivalent for: depreciation. Foreign residential rental property placed in service after 2017 is depreciated straight-line over 30 years under the alternative depreciation system.[IRS, guidance on Section 168(g) ADS recovery periods under the Tax Cuts and Jobs Act, 2026-07] If the building portion of the purchase was 280,000 euros, that is roughly 9,300 euros of annual depreciation. US taxable rental profit: 24,000 − 4,000 − 9,300 ≈ 10,700 euros, against Portugal’s 20,000-euro base.
The credit math. At a 24% US marginal rate, the US tax attributable to the rental is roughly 2,600 dollars, which is also the approximate passive-basket limitation. The Portuguese tax, about 5,400 dollars at recent exchange rates, exceeds the cap. Result: zero US tax due on the Lisbon rent, and roughly 2,800 dollars of excess credit carried back one year and then forward up to ten in the passive basket. IMI never enters the credit; it was deducted on Schedule E.
This pattern, full US offset plus a growing carryforward, is the normal outcome for American landlords in Western Europe.
FAQ
Can I claim both the FTC and the FEIE in the same year?
Yes, on different income: exclude salary under the FEIE, credit foreign tax on rent through Form 1116. The rules prevent double-dipping: no credit for foreign tax paid on the excluded salary, and the stacking rule keeps the rental profit in the bracket the total income implies.
My only foreign tax is 200 dollars of dividend withholding. Do I need Form 1116?
No. The de minimis election (300 dollars single, 600 joint, all passive, all on payee statements) puts the credit straight on Form 1040. The tradeoff is no carryover from that year.
Is my foreign property tax creditable?
No. IMI, IBI, predial, council tax and their equivalents are property taxes, not income taxes. If the property is rented, deduct them on Schedule E; on a pure vacation home they generally produce no US benefit.
Do unused credits expire?
After the one-year carryback, unused credits survive ten years within their basket, then lapse. A filer with passive-basket carryforwards approaching year ten has a reason to time a property sale.
Does a tax treaty change any of this?
Rarely for the core mechanics. Treaties matter here by capping the foreign withholding rate that counts as creditable and, occasionally, by re-sourcing US income as foreign through the treaty basket. The credit itself is US domestic law and works with no treaty in place, which is why it functions in non-treaty countries like Costa Rica or Panama.
Where this fits in the library
This page covers the US-side credit machinery. For why two countries tax the same income and which one yields, start with how double taxation gets resolved. Local costs for an American owner live in the buyer tax guides for Portugal, Spain, and Mexico; the rest of the tax library covers residency lines and treaty structure. Canadians claim a parallel credit under section 126, worked through on the Canadian foreign tax credit page; the return-level rental detail is in how the CRA taxes foreign rental income and the treaty layer in the Canada-US treaty guide.