Form 1116: No foreign capital gains for U.S.-based mutual funds?

It's not foreign source income. When the mutual fund you invested in buys and sells foreign stocks at a gain or loss, it is US source income. When a foreign stock pays a dividend, that is foreign source income. Typically, a mutual fund makes the "certain adjustments" so that you need only report the foreign source income

Alan,

Thank you very much for your response.

I agree with your answer. It's the only one that could explain why U.S.-based mutual funds investing in foreign securities never report foreign capital gains. Something is still puzzling me though...

When U.S.-based mutual funds invest in foreign stocks, I believe they have 3 options:

In the 3rd case, these mutual funds - that often tout their global presence in key world financial markets - don't go through foreign brokers (which, I assume, would eventually generate foreign capital gains)?

The fund is in the US, it owns the shares in the US, so it's US gain when they sell it.

Here's a thought experiment: you, a US resident, go down to your local Travelex in the US one day and buy a thousand euros for $1200. You put them in a drawer for a while, exchange rates change, and later go back and sell them back for $1300. Euros are issued by the ECB in Frankfurt. Is that $100 a US gain or a German gain? If you did these transactions in Canada, would the answer be different?

John,

Thank you very much for your response.

So you're saying that if U.S.-based mutual funds own the shares of foreign stocks, they always own them in the U.S. Therefore, I gather that if these funds own stocks that only trade on a foreign stock market (different from ADRs), they must systematically do it through U.S. brokers (and never through foreign brokers). Maybe there's even a regulation that requires them to do so.

Regarding your thought experiment:

- if a U.S. resident buys euros and later sells them at a gain in the U.S., I would say it's a U.S. gain because the U.S. Travelex office is a U.S. payer;

- if a U.S. resident buys euros and later sells them at a gain in Canada, I would say it's a Canadian gain - that is a foreign gain - because the Travelex office in Canada is a foreign payer (from a U.S. tax perspective). Did I get the right answers?

I don't see why the location of the broker would matter. When you or your fund sell a share of stock, the money comes from a buyer, who could be anywhere, to the seller, minus a sliver for the broker. The only thing that goes to the underlying company is a note telling them where to send the proxies and annual report. But when that stock pays a dividend, the money originates at the company, and they send you your share.

That's why the former is not foreign income, and the latter is.

John,

I think I get it now. When a U.S.-based mutual fund realizes a capital gain, it's a U.S. gain because the fund is a U.S. entity and it owns the shares in the U.S., as you said. It doesn't matter whether the capital gain is realized on U.S. securities or foreign securities.

Conversely, I assume a foreign mutual fund generates foreign capital gains.

Regarding your thought experiment, I still have the same answers as before but based on a revised justification:

- if a U.S. resident buys euros and later sells them at a gain in the U.S., I would say it's a U.S. gain because the gain is realized in the U.S.;

- if a U.S. resident buys euros and later sells them at a gain in Canada, I would say it's a Canadian gain - that is a foreign gain (from a U.S. tax perspective) - because the gain is realized outside the U.S. Did I get the right answers?

Bad example using coins that are personal property. The sale of personal property by a US resident in Canada where the property does not belong to a permanent establishment in Canada is not taxable by Canada and any gain/loss is not foreign source income. This is the general rule in most tax treaties I am familiar with. If the coins were sold in a country that did not have a tax treaty with the US, one would have to look to the tax laws of that country to see if the gain was taxable. Most likely, the sale of personal property would not be taxed and would not be foreign source income.

When it comes to property the general rules are that real property located on foreign soil will generate foreign source income. Personal property that is not part of a fixed base used by the US person for generating income nor belongs to a permanent establishment on foreign soil will not generate foreign source income.