Section 988 Currency Gain Rules for Americans With Sterling

A section 988 currency gain is exchange rate profit that the IRS taxes as ordinary income when you settle a transaction denominated in a foreign currency. For an American in the UK, sterling is the foreign currency. Personal transactions are carved out, but a gain of more than $200 on any one of them is still taxed, and losses are not deductible. This guide covers the mortgage, home sale, savings and investment cases that actually produce a tax bill.

The starting point is a rule the IRS states plainly on its foreign currency page: you must express the amounts on a US return in US dollars, and your functional currency is generally the dollar. Living, earning and borrowing in pounds does not change that. Every sterling amount is translated at the exchange rate prevailing when you receive, pay or accrue the item.

What is a section 988 currency gain?

A section 988 currency gain is the gain on a transaction in a nonfunctional currency that is caused by exchange rates moving between the day the position is booked and the day it is settled. Section 988 of the Internal Revenue Code treats that gain as ordinary income and the matching loss as an ordinary loss.

The transactions section 988 covers include:

• lending or borrowing in a foreign currency, including bank deposits and mortgages;
• income or expenses accrued in a foreign currency and paid later;
• forward contracts, futures, options and similar instruments on a currency; and
• disposing of the foreign currency itself.

The IRS practice unit Overview of IRC Section 988 Nonfunctional Currency Transactions summarizes the three effects: the gain or loss is recognized when the position is sold or settled, it is ordinary in character, and it is sourced by the residence of the taxpayer. The same unit notes that holding shares is not a section 988 transaction. A UK share bought and sold in pounds produces a single capital gain or loss in dollars, with the currency movement folded into it.

The personal transaction exception and the $200 rule

Section 988 was written with businesses and investors in mind, and subsection (e) takes individuals' personal transactions out of it. Two rules follow.

1. Section 988 does not apply to a personal transaction. A personal transaction is any transaction entered into by an individual, except to the extent the related expenses would be deductible as business expenses (section 162) or as expenses of producing income (section 212).
2. Small gains are ignored. When an individual disposes of foreign currency in a personal transaction, no gain from exchange rate movement is recognized, unless the gain that would otherwise be recognized on the transaction is more than $200.

Three points about the $200 rule are often misread. It is tested transaction by transaction, not as an annual allowance. It is a cliff: a $250 gain is taxed in full, not on the $50 excess. And it only removes gains. A currency loss on a personal transaction is a personal loss, and personal losses are not deductible.

Where a personal gain is over the threshold, section 988 still does not apply to it. The gain is taxed under the general rules for property, which normally makes a gain on currency you held as a personal asset a capital gain. The result is one-way: personal currency gains above $200 are taxed, and personal currency losses of any size are not relieved.

Does a section 988 currency gain apply to a UK mortgage?

A sterling mortgage on your own home is a personal transaction, so section 988 itself does not apply, but the currency gain on repaying it is still taxable. The IRS addressed this in Revenue Ruling 90-79. The ruling treats the home and the loan as two separate transactions: one is the purchase and sale of a property, the other is borrowing and repaying pounds.

When you borrow pounds you receive something worth a certain number of dollars. If the pound has weakened by the time you repay, you hand back pounds that cost you fewer dollars than you received. The difference is income. It arises whenever principal is repaid, which includes a sale, a remortgage with a new lender, and a lump-sum overpayment.

Illustrative example, using assumed exchange rates: an American buys a London flat as her home for £500,000 with a £400,000 interest-only mortgage when £1 buys $1.50. In dollars she paid $750,000 and borrowed $600,000. Years later she sells for exactly £500,000 and repays the £400,000 when £1 buys $1.25. The flat shows a dollar loss of $125,000 ($625,000 less $750,000), which is a personal loss and not deductible. The mortgage shows a dollar gain of $100,000 ($600,000 borrowed less $500,000 repaid), which is taxable. She has made nothing in pounds and has $100,000 of US income.

If the pound had strengthened instead, the positions would reverse: a currency loss on the loan that she could not deduct, and a larger dollar gain on the flat. Revenue Ruling 90-79 specifically refuses to let one offset the other.

A mortgage on a rental property is different

A loan that finances a let property is not a personal transaction, because the interest and other costs are expenses of producing income. Section 988 applies in full: a currency gain on repayment is ordinary income, and a currency loss is an ordinary loss that can be deducted. Our guide to US tax on UK rental property covers the rest of the rental calculation, which is also run in dollars.

Selling a UK home: two calculations, one exclusion

A home sale needs two separate dollar computations.

• The property. Translate the purchase price and improvement costs at the rates on the dates you paid them, and the sale price at the rate on the sale date. The difference is the gain or loss on the home. A house that is flat in pounds can show a large dollar gain if sterling has risen since you bought.
• The loan. Translate the amount borrowed at the rate on the day of the loan and each repayment of principal at the rate on the day it is repaid.

The home sale exclusion applies only to the first. Under IRS Topic no. 701, you can exclude up to $250,000 of gain on the sale of a main home, or $500,000 on a joint return, if you owned and used it as your residence for at least two of the five years before the sale. A currency gain on the mortgage is not gain on the sale of the home, so the exclusion does not reach it.

There is a third step people miss. The sale proceeds land in a sterling account. If you convert them to dollars weeks or months later at a better rate, that conversion is its own disposal of currency, and on a six-figure sum the gain can pass $200 with a small movement in the rate.

Sterling accounts, savings and investments: which rule applies?

The treatment depends on whether the transaction is personal or connected to producing income. The table sets out the common cases for a US citizen or green card holder living in the UK.

Transaction in sterling	Personal?	Currency gain	Currency loss
Spending or converting money from an everyday account	Yes	Ignored if $200 or less on the transaction; taxed if more	Not deductible
Repaying a mortgage on your own home	Yes	Taxable (Rev. Rul. 90-79)	Not deductible
Repaying a mortgage on a rental property	No	Ordinary income under section 988	Ordinary loss, deductible
Deposits, bonds or gilts held as investments	Generally no	Ordinary income under section 988 on the currency element	Ordinary loss on the currency element
Forward contract or option on the pound	Depends on purpose	Ordinary under section 988, unless the capital election is made	Ordinary, unless the capital election is made
UK shares	Not a section 988 transaction	Part of the capital gain in dollars	Part of the capital loss in dollars

The line between a personal deposit and an investment deposit turns on the facts: what the money is for, how long it sits, and whether it is managed for a return. That classification should be made deliberately and applied consistently, because it decides whether losses are available as well as whether gains are taxed.

Wages are simpler. Salary paid in pounds is translated into dollars at the rate when you receive it, and that dollar figure becomes your cost in the pounds. There is no currency gain on being paid, only on what happens to the pounds afterwards. The IRS publishes yearly average exchange rates that are widely used for income received evenly through the year, but a single large transaction such as a loan repayment or a property sale needs the rate for its own date.

Why is there usually no foreign tax credit for a currency gain?

There is usually no foreign tax credit because the UK does not tax the event. Sterling is the UK's own currency, so a UK resident who repays a £400,000 mortgage with £400,000 has no gain in UK terms and pays no UK tax on it. With no UK tax paid on that income, there is nothing to credit against the US tax.

That makes currency gains unlike most of an American's UK income. Salary, rental profit and investment income are generally taxed first by HMRC, and the US tax is reduced or eliminated by credits, as our article on foreign tax credit relief explains. A currency gain on a home mortgage can be a net US tax cost. Whether credits carried over from other years can be used against it depends on how the gain is sourced and categorized, and that needs to be worked out on the actual figures.

Reporting currency gains and large losses

A currency gain does not arrive on a form. No UK bank or lender issues a US information return, so the figure has to be built from your own records: the sterling amounts, the dates, and the exchange rate on each date. The IRS does not prescribe a single official rate. Its guidance is to use the rate prevailing at the time and, if there is more than one, the one that most properly reflects your income. Use one published source consistently.

Large deductible losses carry a separate disclosure rule. The Instructions for Form 8886 (Rev. October 2022) treat a loss as a reportable transaction for an individual when it is at least $50,000 in a single tax year and arises from a section 988 transaction. The general threshold for individuals is $2 million in a single year. A section 988 loss on a rental property loan or an investment position can reach $50,000 on quite ordinary amounts, and Form 8886 carries its own penalties when it is missed.

What Americans with sterling get wrong

• Thinking in pounds. "I sold for what I paid" and "I repaid what I borrowed" are both statements in sterling. The US return asks the same questions in dollars.
• Netting the house against the mortgage. The two are separate transactions. A loss on one does not reduce a gain on the other.
• Treating $200 as an annual allowance. The threshold applies to each transaction and disappears entirely once the gain on that transaction exceeds it.
• Assuming losses balance gains. On personal transactions they do not. Gains above the threshold are taxed and losses are not allowed.
• Forgetting the remortgage. Moving a loan to a new lender repays the old one. That is a settlement in dollars even though you never saw the money.
• Converting a lump sum without checking the cost. A transfer of savings or sale proceeds into dollars is a disposal of currency. The gain depends on when and at what rate those pounds were acquired.

Planning before you repay, sell or convert

These gains are created on specific dates, so they can be measured before the transaction happens.

1. Find the dollar value of the loan on the day it was drawn. That figure is fixed for the life of the mortgage and is the benchmark for every repayment.
2. Model the repayment at current rates. Compare the dollars originally borrowed with the dollars needed to repay today.
3. Check the home sale exclusion separately. Confirm the ownership and use tests and compute the property gain in dollars on its own.
4. Decide what happens to the proceeds. Converting on completion, converting later and keeping sterling each have a different US result.
5. Keep the evidence. Completion statements, loan statements and the exchange rate source for each date should stay with your tax records.

If a move is part of the picture, our US/UK moving abroad tax checklist sets out the wider sequence, and the guide to cross-border investor tax reporting covers investment accounts held in pounds.

US/UK Cross Border Tax is a firm of US CPAs and UK tax advisers working as one team, with offices in London, Manchester, New York and San Francisco. We calculate each section 988 currency gain on your US individual tax return alongside the property and loan figures, and our cross-border property team models a sale or remortgage before you commit to a date. If you are one of the Americans living in the UK with a sterling mortgage or a large balance to convert, contact us before the transaction, not after it.