My wife (Japanese) and I (U.S.) have a higher level of financial complexity then the typical couple.
We are in our late 40's and interested in returning to Japan for several years, but NOT indefinitely and my wife will likely be subject to the exit tax given the current and projected trajectory of the Yen exchange rate. I would be as well if I became a Permeant Resident.
We are fine with paying Capital Gains Taxes to the Japanese NTA from her investment portfolio ideally with the ability to offset those taxes when she does a Roth Conversion and uses the FTC in the U.S.
However most of her investment Portfolio is held with the her Roth and Traditional IRA's. For a U.S. perspective she can buy and sell within both IRA's without any tax consequences. It only becomes taxable when she does a Roth Conversion or distribution and we will not be doing a distribution while living in Japan.
I am wondering if we can we take phantom capital gains by selling and then rebuying stocks within the IRA's to reset the cost basis in the eyes of the Japanese NTA and pay capital gains taxes to the NTA each year. At the same time do Roth Conversions in the U.S. so that the tax consequence in the U.S. effectively get cancelled out when using the FTC when we file our U.S. taxes.
By upping the cost basis in the eyes of Japanese NTA we can reduce the exit tax when we depart Japan.
I'm just not sure how she would show the NTA that she upped the cost basis as there is no tax form generated when buying and selling within IRA's which is unlike a typical brokerage account.
by Throwaway4567894246
3 comments
TLDR: You might want to rethink your strategy to do a Roth conversion.
First, you are very smart to plan in advance. There are actions you can only take before moving to Japan that will impact your future income tax and gift/inheritance tax. I’ll focus on replying to your questions about capital gains tax on Roth IRA accounts, but you should also consider what actions you might want to take to reduce future gift/inheritance tax. And yes, spouses are subject to gift tax, believe it or not.
Regarding exit tax… You will become liable for exit tax after you have been resident for more than 5 of the past 10 years on a spouse visa or PR. So getting PR doesn’t affect anything for you.
Your post implies that Japan income tax will be applied to capital gains within the Roth account. This is possible, but not necessarily correct. In fact, until a few days ago the preponderance of evidence was pointing that seemed to be pointing towards only distributions being taxable. But a couple of days ago someone posted in this subreddit that they were advised by the tax office that only the capital gains were taxable, only to be advised later by a different person at the tax office that both the capital gains and the distributions are taxable.
This situation exists because 401k/IRA accounts don’t fit well into Japan income tax law, and as far as anyone can tell, the NTA has not provided any official clarifications. And guessing from the recent experience mentioned in the paragraph above, it’s unlikely that NTA has any internal guidance either.
Something else you should factor in your planning is the effect that a Roth conversion has on double taxation. US foreign tax credits can only be carried forward 10 years. So the taxes you pay during the conversion cannot be recovered unless you have Japan taxes in the next 10 years that are within the same FTC income category and that add up to the US taxes on the conversion.
And another consideration is that Japan income tax on Roth related income could be significantly higher than the tax you would pay on capital gains for a regular brokerage account.
Considering all this, it doesn’t surprise me that a common financial strategy mentioned in this subreddit is to cash out Roth accounts before moving to Japan. But your situation sounds a little different, since you don’t currently have a Roth. I assume you have a traditional IRA or a 401K?
Another potential strategy is to do a rollover (from traditional IRA and/or 401k to traditional IRA) from one financial institution to another. The thought is that by cashing out the investments inside the 401k and/or traditional IRA and receiving a rollover check that goes to open a new traditional IRA, one could argue to the NTA that this resets the cost basis of investments within the account and it also resets the contribution basis for determining how much of the distribution is income.
I should also point out that “phantom gains” (and “phantom losses”) are a result of differences between the exchange rates when the investments are purchased and sold. So for example, a phantom loss would occur if one purchased an investment now when the exchange rate is 130 and sells in the future when the exchange rate is 100. It’s not a real loss, it’s just that the cost basis gets a 30% bump compared to the funds received when the investment is sold.
In summary, it’s a complicated situation that requires a bit of thought for you to decide what is the right strategy for your situation.
The way you describe it, it sounds like you’ll be just over the threshold, in which case I would suggest:
1. Do the basis reset before heading to Japan.
2. Shortly before leaving Japan, sell everything in the IRA/401k and hold it as cash, as cash doesn’t count toward the limit.
3. As you’re under the limit, no exit tax
>selling and then rebuying stocks within the IRA’s to reset the cost basis in the eyes of the Japanese NTA and pay capital gains taxes to the NTA each year
Your post appears to be based on the assumption that transactions occurring within IRAs would be taxable in Japan. While such a view is not outside the scope of possibility, all professional commentary I have ever seen on this issue has said that transactions within IRAs are not taxable in Japan—instead, distributions are taxable (when received by a resident of Japan) based on the difference between the contributions and the value of the account at the time of distribution. This is not a completely settled issue, as discussed by u/shrubbery_herring, but I think the latter approach (distributions are taxable, not transactions occurring within the account) makes a lot more sense, especially in light of the US-Japan tax treaty.
Furthermore, if transactions within IRAs are not taxable in Japan (only distributions), then IRAs wouldn’t count for the purposes of Japan’s exit tax. The range of assets that are subject to the exit tax is defined quite narrowly, and doesn’t include private pensions/annuities/etc., which is likely the category that IRAs would end up in (i.e., taxable upon distribution). The exit tax is largely limited to securities held in ordinary brokerage accounts.