Taxing Foreign Capital Gains: Revenue Potential and Policy Tradeoffs

The United States generally does not tax capital gains earned in the U.S. by foreign investors who are not engaged in a U.S. trade or business.[i] This is due to sourcing rules under Internal Revenue Code §865, which states that gains from the sale of personal property, like stocks and bonds, are typically sourced to the seller’s residence, not the location where the gain occurred.[ii] For example, if someone who lives in France (and does not meet the U.S. presence requirements) sells their Amazon stock for a profit, they will not be taxed on any of the gain they earn. The gain will be treated as foreign-source income and will not be subject to U.S. tax, even though the stock is traded on a U.S. exchange. In contrast, U.S. taxpayers are taxed on both long- and short-term capital gains, depending on how long they have held the asset.[iii] The treatment of capital losses also differs between foreign and domestic investors: domestic investors can use capital losses to offset their capital gain liability, [iv]  while foreign investors do not have capital gain liability to offset with their losses.[v] 

The policy rationale for not taxing capital gains from U.S. non-residents is twofold: to encourage foreign investment in U.S. capital markets[vi] and to address the practical difficulty of enforcing tax collection against non-resident investors.[vii] Foreign investors own approximately 21% of U.S. securities, maintaining a consistent share of the market for the last decade or so.[viii] This shows how integrated foreign capital is in U.S. markets and illustrates why taxing foreign gains could represent a meaningful source of revenue. However, would the behavioral responses to taxing foreign investors offset revenue gains? It’s not clear that the U.S. market is dominant enough to prevent capital from adjusting. Imposing a capital gains tax could decrease demand for U.S. equities or redirect investment to other jurisdictions. There is also ambiguity about how losses would be treated, whether, as in the Passive Foreign Investment Company context, they would be effectively disregarded or instead allowed to offset gains, which would further influence investor behavior.[ix]

The withholding regime for fixed, determinable, annual, or periodical (FDAP) income serves as a viable enforcement model for capital gains earned by foreign individuals.[x] The IRS could implement a similar system on foreign capital gains by requiring brokers to withhold tax at the point of sale. Unlike dividends, however, capital gains taxation requires accurate tracking of cost basis, holding period, and other adjustments, [xi]  making it significantly more complex to track for foreigners due to lack of information sharing and privacy laws.[xii] While U.S. brokers do report cost basis for many securities, which helps address the issue in part, it doesn’t entirely remedy it. Gaps still exist, especially for assets transferred from foreign accounts, older positions, and certain non-covered securities, which makes it difficult to rely entirely on broker data for withholding. [xiii]

Given the steady increase in foreign participation in U.S. capital markets over the past two decades, the question of whether to tax capital gains earned by foreign investors warrants serious consideration. At a minimum, it presents a meaningful policy choice between maintaining the current system, which prioritizes openness and simplicity, and exploring whether that same system is leaving revenue on the table at a time when fiscal pressures continue to grow.

Freya Stavis is a staff member of Fordham International Law Journal Volume XLIX.

[i] See I.R.C. § 865(a)(2); I.R.C. § 865(g)(1)(B).

[ii] See I.R.C. § 865; I.R.C. § 871(a).

[iii] See I.R.C. § 1222(1)–(4); I.R.C. § 1(a)–(e).

[iv] See I.R.C. § 1211(b).

[v] See I.R.C. §§ 865(a)(2), (g)(1)(B).

[vi] See Current U.S. International Tax Regime: Hearing Before the H. Comm. on Ways & Means, 106th Cong. 81 (1999), https://www.congress.gov/106/chrg/CHRG-106hhrg65844/CHRG-106hhrg65844.pdf.

[vii] See Reuven S. Avi-Yonah, The Structure of International Taxation: A Proposal for Simplification, 74 Tax L. Rev. 1301, 1336–38 (1996).

[viii] U.S. Dep’t of the Treasury, Foreign Portfolio Holdings of U.S. Securities as of June 28, 2024 (Apr. 30, 2025), https://ticdata.treasury.gov/resource-center/data-chart-center/tic/Documents/shl2024r.pdf.

[ix] See I.R.C. §§ 1291–1298 (reflecting a regime that does not provide general loss offset under § 1291 and limits loss recognition under § 1296).

[x] See I.R.C. § 1441; see also Avi-Yonah, supra note vi, at 1337–38.

[xi] See IRS, Publication 550, Investment Income and Expenses, https://www.irs.gov/publications/p550.

[xii] See Richard Phillips, Foreign Account Tax Compliance Act (FATCA): A Critical Anti-Tax Evasion Tool (Inst. on Tax’n & Econ. Pol’y, May 2017), https://itep.sfo2.digitaloceanspaces.com/fatcaguide2017.pdf (noting that while under the Foreign Tax Compliance Act foreign financial institutions have to report account balances and certain income or proceeds, they are not required to report cost basis analysis or transaction specific details).

[xiii] Id.

This is a student blog post and in no way represents the views of the Fordham International Law Journal.