I am often asked how can a capital gain associated with your main residence that is tax-free in Australia be taxable in the U.S.? For most Australians, they think, ‘this is insane and nonsensical! How can this be!’ It may hurt to hear this but the reason is quite simple and it is very logical…

Australia actually has a very outdated approach to the taxation of real estate – when compared with other countries that are members of the OECD. The country is very long on real estate. You talk to your relatives about investments they want to talk about real estate. You talk to your best friend. He or she wants to talk about real estate. You talk to your cabi (Aussie taxi driver) he wants to talk about real estate. You know what, if you talk to me I want to talk about real estate!

Australians LOVE real estate. Actually they don’t love it, they froth over it. Who doesn’t love an asset class where capital growth is not subject to tax. For a second, forget you don’t LOVE real estate and ask yourself, how is that equitable and what is the policy basis for that? Do you think allowing something to pay no tax on a $100m capital gain associated with one asset class will distort the market and weight asset allocation in favour of the main residence to more productive assets classes? Of course it will. Do most people question it? Of course not. It is a bit like legalizing two-up for a day. Does it make any sense. Not really. Is it awesome? Yes. End of discussion!

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The U.S. on the other hand, does not want to gamble with the American dream. While they support home ownership they want to cap the incentives associated with developing massive homes for personal use.

Two-up aside, why doesn’t the double tax agreement ensure an Australian capital gain associated with the sale of a main residence is not taxed in the U.S.? The answer again is very simple, double tax agreements only govern tax issues where this is alignment on tax policy. The U.S. does not believe that a $100m capital gain on a main residence should be tax-free, which to U.S. policymakers makes about as much sense as legalizing a coin toss across the country for a day!

Just so you know, I love two-up and I love tax-free outcomes but I hope you can now see how logical the U.S. tax treatment is.

If you are a U.S. tax resident and a non-resident of Australia, put away the two-up paddle and apply the U.S. tax rules.