Foreign mortgage currency gains: the hidden US tax

You borrowed 400,000 pounds and paid back 400,000 pounds, and the IRS says you made money. Welcome to the phantom gain.

The short version

The IRS thinks in dollars. Every foreign-currency amount on your US return is translated into USD, including a mortgage you took out and paid off abroad [1][2].
If the local currency falls against the dollar while you owe the loan, paying it off creates a dollar gain. It's taxable, even though you received no cash [3][4].
If the currency rises, the loss on a home mortgage isn't deductible. A federal appeals court confirmed that lopsided result in 1996 [3].
Rentals are treated differently. A mortgage on an investment property falls under Section 988, so gains and losses are ordinary and losses can count [5].
Payoffs, sales and refinances are the usual trigger points. Plan them with the exchange rate in mind.

Why paying back the same amount can be "income"

The US dollar is your functional currency. The IRS says so in black and white: unless you run a qualifying foreign business unit, you "must make all federal income tax determinations" in dollars [1]. You translate each item at the exchange rate "prevailing when you receive, pay, or accrue the item" [2].

Now think about the mortgage as two separate events in dollars:

When you borrow, you receive foreign currency worth a certain number of dollars on that day.
When you repay, you hand over foreign currency worth a different number of dollars on that day.

If the foreign currency weakened in between, you repaid fewer dollars than you borrowed. In US tax eyes, that difference is a gain from paying off a debt for less than its dollar value. Your bank in London or Frankfurt doesn't see any gain at all, because to them a pound is a pound.

A worked example in pounds

USD conversions in this guide use the Federal Reserve H.10 rate of October 30, 2026: USD 1.3398 per British pound. The borrowing rate below is an illustration, not a historical quote.

Step	Pounds	Exchange rate	Dollar value
Borrow to buy a home in Bristol	GBP 400,000	USD 1.60 (illustration)	USD 640,000
Pay the loan off when you sell	GBP 400,000	USD 1.3398	about USD 535,900
Dollar gain on the loan			about USD 104,100

That's a six-figure gain on paper, with no check in your hand. A UK example from a large accounting firm makes the same point with a smaller loan and notes that the taxpayer "hasn't received any money to incur this liability" [4].

Now look at the house itself. Say it cost GBP 500,000 at USD 1.60 (USD 800,000) and sold for GBP 550,000 at USD 1.3398 (about USD 736,900). In pounds you made GBP 50,000. In dollars you lost about USD 63,100. On a personal home that dollar loss isn't deductible, but the dollar gain on the loan is taxable. That's the trap in one sentence.

The court case that set the rule

This isn't a gray area that only tax geeks argue about. In Quijano v. United States, a couple bought a home in the UK in 1986 for GBP 297,500, financed fully with a pound mortgage, and sold it in 1990 [3]. They wanted to measure everything in pounds. The First Circuit said no.

What the court held [3]:

The mortgage is a separate transaction from buying and selling the house.
A currency loss on a personal-residence mortgage isn't deductible, because the loan wasn't part of a business or a profit-seeking activity.
You can't switch your functional currency to pounds just because you live in the UK.
Currency gain on the sale is real income that "plainly qualifies as realized income."

That decision is from 1996, but the logic still runs through how preparers treat foreign homes today.

Personal home vs rental: Section 988

Section 988 of the tax code covers foreign currency transactions, including "becoming the obligor under a debt instrument," which is a fancy way of saying taking out a loan [5]. Its gains and losses are ordinary income or loss [5].

But Section 988 doesn't apply to an individual's "personal transaction," which is anything that isn't a business or investment activity [5]. That split decides how your mortgage is taxed.

Your property	Rule that applies	Currency gain on the loan	Currency loss on the loan
Main home or vacation home	General tax principles, not Section 988 [5]	Taxable [3]	Not deductible [3]
Rental or investment property	Section 988 [5]	Ordinary income	Ordinary loss, generally deductible

There's a small break for travelers: when you dispose of foreign currency in a personal transaction, gains of USD 200 or less aren't taxed [5]. That covers leftover euros from a vacation. It does nothing for a mortgage.

How the personal-home gain is classified, and which line of the return it lands on, is technical. A US expat tax preparer (or a lawyer) can check your situation.

When the gain gets triggered

Technically, every repayment of principal is a small realization event, and some advisers treat monthly principal payments that way [4]. In practice, the big numbers usually show up at these moments:

Selling the home and paying off the loan. The whole remaining balance is repaid at one exchange rate.
Refinancing or remortgaging. Paying off one loan with a new one counts as repaying the old loan, even if you never touch the cash [4]. Switching lenders can change the result [4].
Overpaying or paying a lump sum, such as from a bonus or an inheritance.
Converting a fixed-rate deal at the end of its term if the bank treats it as a new loan.

Euro, yen and Swiss franc mortgages work the same way. The bigger the move in the exchange rate and the bigger the loan, the bigger the number.

Why there's usually no foreign tax credit to help

Your host country doesn't see a gain. To HMRC or the Agencia Tributaria, you borrowed euros and repaid euros. No local tax means no foreign tax to credit against the US tax [6].

The foreign earned income exclusion doesn't help either. A currency gain isn't earned income from your work. If you already pay more local tax than US tax on your salary, you may have extra foreign tax credits in some years, but whether they can absorb a currency gain depends on its source and its category [4]. That's a question for a professional, ideally before the payoff.

How to see it coming

You can't control exchange rates, but you can control timing and paperwork:

Record the rate on the day you borrowed. Keep the closing statement and note the dollar rate that day. Without it, nobody can work out the gain later. The IRS lists banks and US embassies as sources for rates [2].
Track the dollar value of your balance once a year. A simple spreadsheet with the balance, the year-end rate and the original rate tells you if you're sitting on a gain or a loss.
Time big repayments. If you have flexibility, paying down principal in a year when the local currency is strong can shrink the gain.
Think before you refinance. A remortgage with a new lender can lock in a gain you'd otherwise defer. Ask whether a product switch with the same lender is treated differently [4].
Use a lower-income year. If the gain is coming anyway, a year with less other income can mean a lower rate.
Get advice in the year of the sale. The home-sale exclusion can shelter a gain on the house itself, but it doesn't cover the separate gain on the loan [3][7].

Currency gains on a foreign mortgage: the US tax nobody warns you about