U.S. tax on a foreign property sale

Dear Tax Talk,
I have several questions about a sale of a foreign property that was previously privatized, i.e., transferred from state ownership to private ownership. A family lived in Russia in an apartment that they owned and that was privatized from the state some time in the 1990s. Privatization involved simply filling out some forms. Since then all members of the family at different times became U.S. legal residents. The apartment was sold in Russia last year.

1. Is any part of the proceeds of the sale taxable in the United States and, if so, what is the tax basis for the apartment?
2. The apartment was the primary residence for the family until they became U.S. permanent residents. Does this affect how the sale is taxed?
3. Does the fact that the family became U.S. residents relatively recently, i.e., long after privatization took place, affect the tax basis?

Thank you for your help.
-- Sergei

As a U.S. resident you're obligated to pay tax on your worldwide income. This would include the sale of property wherever located. The cost of property for purposes of computing gain is the amount paid. If the owners did not pay for the apartment in the process of privatization, then their cost was zero. By becoming U.S. residents, their historical cost is not adjusted for any pre-immigration appreciation in value. For example, if residents sell a piece of property the day after they become residents and they had owned that property all their lives, their cost is traced back all the way to when they originally purchased the property as nonresidents. If they had sold the property prior to becoming residents, they of course would not have been taxed on the sale in the U.S.

The rules with respect to taxes and the sale of a principal residence would apply to the sale of the property, even though it is outside the U.S. They could claim the $250,000 (or $500,000 exclusion for a married couple) if they owned and used the property as their principal residence for two years within the last five years prior to the date of sale. Their use as a U.S. nonresident would still count toward the two years.

They would not be able to claim the property as their principal residence after becoming residents as this is contrary to their residence status. That is, they could not claim to be U.S. residents while maintaining their principal residence in a foreign country.