The US Tax Bill Hiding in Your Foreign Mortgage: Currency Gain on Repayment and Refinancing

Published on: September 1, 2026

Last reviewed: September 2026. This is general educational information about a well-documented area of US federal tax law. It is not tax advice, it does not create a professional relationship, and it cannot account for your circumstances. Foreign currency taxation is one of the areas where competent advisers reach different conclusions on the same facts. Speak to a US-qualified tax professional experienced in cross-border matters before acting.

Quick answer:

• For US tax purposes the loan and the house are two separate transactions. Repaying the mortgage is a closed transaction in its own right.
• A stronger dollar can produce a taxable gain with no sale and no cash arriving. Practitioners call it a phantom gain.
• On a personal residence the treatment is asymmetric: the currency gain is taxable and the matching loss is not deductible.
• On a rental or business property section 988 applies, the gain or loss is ordinary, and losses are generally deductible.
• The section 121 exclusion does not shelter it, and foreign tax credits often cannot absorb it because the gain is usually US-source.

Here is the situation that catches people out. An American buys a house in Europe with a euro mortgage. Years later the dollar has strengthened, so she refinances to a better rate. She has not sold the house. She has not moved a dollar across the ocean. She has borrowed the same number of euros she owed and paid off the old lender.

On her US return, that refinancing may have produced a large taxable gain.

The gain is real in the eyes of the Internal Revenue Service and imaginary in the eyes of the taxpayer, which is why practitioners call it a phantom gain. It is not a loophole, an aggressive position or an obscure risk. It follows from a settled principle: for US tax purposes, the loan and the house are two separate transactions.

The core principle: the loan is its own transaction

When a US taxpayer borrows in a currency other than the US dollar, the debt is measured in dollars at the exchange rate on the day it was taken out. When the debt is repaid, it is measured again at the rate on the day of repayment. If it takes fewer dollars to extinguish the debt than the dollar amount originally borrowed, that difference is a gain.

Crucially, this is computed separately from the gain or loss on the property. A profitable sale of the house can sit alongside a currency loss on the mortgage, and a loss on the house can sit alongside a taxable currency gain on the mortgage. They do not net against each other.

The IRS position is set out in Revenue Ruling 90-79, which states that the borrowing and repayment of the mortgage loan is a separate transaction from the purchase and sale of the residence, and that repayment of the mortgage is a closed and therefore taxable transaction. The First Circuit upheld that ruling in Quijano v. United States, 93 F.3d 26 (1st Cir. 1996), in a case where a couple who had bought and sold a London home tried to offset their mortgage-side loss against their property-side gain and were not permitted to.

A worked example

Numbers rounded for clarity. Assume a US taxpayer with the US dollar as her functional currency.

• She borrows EUR 400,000 when the rate is 1.20 USD per EUR. Dollar value of the debt at origination: USD 480,000.
• Six years later she refinances the full balance. She still owes EUR 400,000, but the rate is now 1.05. Dollar cost of extinguishing the debt: USD 420,000.
• Difference: USD 60,000.

In euro terms she borrowed 400,000 and repaid 400,000. In dollar terms she discharged a 480,000 obligation for 420,000. That USD 60,000 is the amount at issue.

Run the same example with the currency moving the other way and the taxpayer has a USD 60,000 loss, which brings us to the part that makes this genuinely unfair.

Two different regimes, and which one applies matters enormously

This is where most short summaries get it wrong, including many that cite "Section 988" as though one rule covers everything.

If the mortgage finances a personal residence. Section 988 contains a carve-out for individuals: its rules apply to an individual's transaction only to the extent that expenses allocable to the transaction meet the requirements of section 162 (trade or business) or section 212(1) or (2) (production of income). A mortgage on a home you live in has no such expenses. Revenue Ruling 90-79 therefore concludes that section 988 does not apply, and that the law predating section 988 governs. Under that older law the repayment is still a closed, taxable transaction, and any loss is a personal loss that is not deductible because it was not incurred in an activity described in section 165(c).

The result is an asymmetry: a currency gain on a personal-residence mortgage is taxable, and a currency loss on the same mortgage is not deductible. Practitioners describe this as a whipsaw, and it is exactly what the taxpayers in Quijano ran into.

If the mortgage finances a rental or business property. Now there are expenses allocable to the transaction under section 162 or section 212, so section 988 does apply. Currency gain or loss is computed separately, is ordinary in character rather than capital, and losses are generally deductible as ordinary losses.

A note on the $200 personal exception. Section 988(e) also contains a de minimis exclusion of $200 for gain on the disposition of nonfunctional currency in a personal transaction, which is the rule that saves you from reporting the euros left in your wallet after a holiday. It applies to disposing of currency itself, not to the repayment of a debt instrument, so it does not solve the mortgage problem.

The character of the gain on a personal-residence mortgage is the point where practitioners most often differ. Revenue Ruling 90-79 addresses the loss side directly and does not settle the character of the gain; ordinary treatment is the common position in practice. This is precisely the sort of question to put to your preparer rather than to a website.

Events that can trigger it, including several people do not expect

• Selling the property and repaying the mortgage from the proceeds
• Refinancing with a new lender
• Remortgaging with the same lender where the old loan is discharged and a new one written
• A substantial lump-sum overpayment of principal
• Repaying the loan on schedule at the end of its term
• Converting an interest-only loan to a repayment loan, where the old obligation is extinguished
• Repaying a loan denominated in a currency other than the one your income is in, which is a separate and compounding risk covered in our guide to the foreign currency mortgage trap

The pattern is that the trigger is the discharge of the obligation, not the sale of the house. Anyone who assumes they are safe because they are not selling has misread the risk.

Three further points that change the size of the bill

The section 121 exclusion does not help. The exclusion for gain on the sale of a principal residence applies to the gain on the residence. It does not shelter the separate gain arising on the mortgage.

Foreign tax credits often cannot absorb it. Currency gain of this kind is generally sourced by reference to the residence of the taxpayer, which for a US person usually means US-source income. Foreign tax credits are of limited use against US-source income, so a taxpayer who assumed local tax paid abroad would cover the bill can be badly wrong.

Net investment income tax. Whether the 3.8% net investment income tax reaches the gain is a further question practitioners approach differently depending on the facts. Raise it explicitly with your adviser rather than assuming either answer.

The records to keep, starting today

If you own foreign-currency-denominated debt and you are a US taxpayer, the whole exercise becomes far cheaper if you keep these from day one:

• The loan agreement, showing the original principal in the foreign currency and the drawdown date
• The spot rate on the drawdown date, and the source you used for it
• Every subsequent principal repayment: date, amount in foreign currency, spot rate that day
• Documentation of every refinance, product switch or lender change, showing whether the original obligation was discharged
• The same records for any currency conversions made to fund those payments, which our guide to transferring money abroad covers on the payment side
• A consistent, documented methodology for which published rate you use

Reconstructing fifteen years of exchange rates after the event is expensive and error-prone. Keeping a single spreadsheet from the start is not.

Who this applies to

US citizens and green card holders are taxed on worldwide income regardless of where they live, so this reaches Americans in London, Lisbon, Sydney and Dubai equally. It also reaches US residents who own property abroad, and it can reach people who did not think of themselves as American taxpayers at all, including accidental Americans born in the United States to non-US parents.

It does not, as a rule, work in reverse: most other countries do not tax an individual on exchange-rate movement in a personal mortgage. The US treatment is unusual, which is exactly why it surprises people who have taken advice locally and assumed it was complete.

Where this fits with the rest of the US cross-border stack

Currency gain on a mortgage is the missing link in a chain most American owners abroad already know parts of: FBAR and FATCA reporting on the accounts, capital gains on the property itself, potential PFIC issues if the property is held through a fund structure, FIRPTA if the property is in the US and the seller is not, and section 1031 rules which since 2017 no longer apply to foreign real property exchanged for US property. The mortgage leg is the one that appears in almost none of the general guides.

Frequently asked questions

I did not receive any money. How can there be a gain?
Realisation for US tax purposes does not require cash to arrive. Discharging a liability for fewer dollars than it was recorded at is treated as a closed transaction. The absence of cash is why the tax can be painful, since there is nothing liquid to pay it from.

What if the currency moved against me?
On a personal residence, the loss is generally not deductible. On a rental or business property, section 988 applies and the loss is generally an ordinary loss. This asymmetry is the single strongest argument for getting the characterisation right.

Does this apply if I bought the property in cash?
No. With no foreign-currency debt there is no separate loan transaction. You still have exchange-rate effects inside the property gain calculation, since basis and proceeds are each translated at their own dates, but the mortgage issue does not arise.

Does it apply to a mortgage on a US property held by a US person in dollars?
No. The issue arises from debt denominated in a currency other than your functional currency.

Can I plan around it?
Timing, loan structure, whether a property is held personally or in an entity, and whether it is a residence or a rental all affect the outcome. All of that is fact-specific and belongs with a qualified adviser who can see your full position. Anyone offering a general answer to this question online should be treated with suspicion.

Keep reading on JanusHermes

The practical defence is unglamorous: know whether your mortgage sits on the personal-residence side or the rental side of the line, and keep the drawdown date, the spot rates and every discharge event in one place from the day the loan completes. JanusHermes lists property from local agencies in 11 languages, with the local agency's own contact details on every listing.

Related reading: Capital Gains Tax on Overseas Property, The Foreign Currency Mortgage Trap, FATCA, FBAR and Form 8938 for Americans, CRS and the Foreign Property Owner, Transferring Money Abroad to Buy Property, FIRPTA for Foreign Sellers of US Property and The US Non-Resident Estate Tax Trap.

Primary sources: IRC §§985-989, in particular §988(c)(1)(B)(i) and §988(e); Rev. Rul. 90-79; Quijano v. United States, 93 F.3d 26 (1st Cir. 1996); IRS International Practice Unit on nonfunctional currency transactions.

This article is general information as of 2026 and does not constitute tax, legal or financial advice. Foreign currency taxation is an area where competent advisers reach different conclusions on the same facts; speak to a US-qualified tax professional experienced in cross-border matters before acting.