At the outset, let me remind you of the important disclaimer at the
bottom of the page -- Google Answers is no substitute for professional
tax/legal/financial advice. Please seek the services of a tax
professional before making any decisions based on the information
Your friends at the IRS have prepared a detailed publication that
addresses the issue of what they refer to as "blocked income" --
foreign currency that is not convertible to US dollars.
The same publication includes a great deal of information on how
foreign income is handled vis a vis tax reporting, so I would
certainly encourage you to give the entire document a thorough
The publication in question is:
Publication 54 (2004), Tax Guide for U.S. Citizens and Resident Aliens Abroad
In particular, some of the language in the first chapter is very
specific to the issue of non-convertible currency, as you can see from
the excerpts below:
This chapter discusses...How to treat foreign currency
You generally must report your foreign income in terms of U.S. dollars
and, with one exception (see Fulbright Grant, later), you must pay
taxes due on it in U.S. dollars.
If, because of restrictions in a foreign country, your income is not
readily convertible into U.S. dollars or into other money or property
that is readily convertible into U.S. dollars, your income is
"blocked" or "deferrable" income. You can report this income in one of
Report the income and pay your federal income tax with U.S. dollars
that you have in the United States or in some other country, or
Postpone the reporting of the income until it becomes unblocked.
If you choose to postpone the reporting of the income, you must file
an information return with your tax return. For this information
return, you should use another Form 1040 labeled "Report of Deferrable
Foreign Income, pursuant to Rev. Rul. 74-351." You must declare on the
information return that you will include the deferrable income in your
taxable income for the year that it becomes unblocked. You also must
state that you waive any right to claim that the deferrable income was
includible in your income for any earlier year.
You must report your income on your information return using the
foreign currency in which you received that income. If you have
blocked income from more than one foreign country, include a separate
information return for each country.
Income becomes unblocked and reportable for tax purposes when it
becomes convertible, or when it is converted, into dollars or into
other money or property that is convertible into U.S. currency. Also,
if you use blocked income for your personal expenses or dispose of it
by gift, bequest, or devise, you must treat it as unblocked and
If you have received blocked income on which you have not paid tax,
you should check to see whether that income is still blocked. If it is
not, you should take immediate steps to pay tax on it, file a
declaration or amended declaration of estimated tax, and include the
income on your tax return for the year in which the income became
If you choose to postpone reporting blocked income and in a later tax
year you wish to begin including it in gross income although it is
still blocked, you must obtain the permission of the IRS to do so. To
apply for permission, file Form 3115, Application for Change in
Accounting Method. You also must request permission from the IRS on
Form 3115 if you have not chosen to defer the reporting of blocked
income in the past, but now wish to begin reporting blocked income
under the deferred method. See the instructions for Form 3115 for
As you can see, under some circumstances you can defer reporting of
any income that is considered "blocked income", i.e., income that is
non-convertible to US dollars.
Note the condition above that if you are using the non-convertible
currency for "personal expenses" then you cannot treat it as "blocked
income". In this case, it is simply foreign currency, and subject to
the requirements laid out in the same chapter. Here are some relevant
You must express the amounts you report on your U.S. tax return in
U.S. dollars. If you receive all or part of your income or pay some or
all of your expenses in foreign currency, you must translate the
foreign currency into U.S. dollars. How you do this depends on your
functional currency. Your functional currency generally is the U.S.
dollar unless you are required to use the currency of a foreign
You must make all federal income tax determinations in your functional
currency. The U.S. dollar is the functional currency for all taxpayers
except some qualified business units (QBUs). A QBU is a separate and
clearly identified unit of a trade or business that maintains separate
books and records.
Even if you have a QBU, your functional currency is the dollar if any
of the following apply.
You conduct the business in dollars.
The principal place of business is located in the United States.
You choose to or are required to use the dollar as your functional currency.
The business books and records are not kept in the currency of the
economic environment in which a significant part of the business
activities is conducted.
Make all income tax determinations in your functional currency. If
your functional currency is the U.S. dollar, you must immediately
translate into dollars all items of income, expense, etc. (including
taxes), that you receive, pay, or accrue in a foreign currency and
that will affect computation of your income tax. Use the exchange rate
prevailing when you receive, pay, or accrue the item. If there is more
than one exchange rate, use the one that most properly reflects your
income. You can generally get exchange rates from banks and U.S.
If your functional currency is not the U.S. dollar, make all income
tax determinations in your functional currency. At the end of the
year, translate the results, such as income or loss, into U.S. dollars
to report on your income tax return.
By my reading of the above, you would be expected to use the
prevailing exchange rate to convert the local currency into US
dollars. The fact that it is bond income does not appear to be
relevant to the situation -- income is income, as far as reporting
Investment income, as a rule, is not considered part of what the IRS
terms "earned income":
2) I qualify under the bona fide residence test. Does my foreign
earned income include my U.S. dividends and the interest I receive on
a foreign bank account?
No. The only income that is foreign earned income is income from the
performance of personal services abroad. Investment income is not
earned income. However, you must include it in gross income reported
on your Form 1040.
As the above suggest, earned income (e.g. actual salary income) may be
subject to income tax exemptions, even though bond income would not
be. I have included some relevant information on exemptions for
earned income, in case this is of interest to you as well:
4. Foreign Earned Income and Housing: Exclusion - Deduction
This chapter discusses:
....Who qualifies for the foreign earned income exclusion, the foreign
housing exclusion, and the foreign housing deduction,
...How to figure the foreign earned income exclusion, and
...How to figure the foreign housing exclusion and the foreign housing deduction.
Who Qualifies for the Exclusions and the Deduction?
If you meet certain requirements, you may qualify for the foreign
earned income and foreign housing exclusions and the foreign housing
If you are a U.S. citizen or a resident alien of the United States and
you live abroad, you are taxed on your worldwide income. However, you
may qualify to exclude from income up to $80,000 of your foreign
earnings. In addition, you can exclude or deduct certain foreign
housing amounts. See Foreign Earned Income Exclusion and Foreign
Housing Exclusion and Deduction, later.
You may also be entitled to exclude from income the value of meals and
lodging provided to you by your employer. See Exclusion of Meals and
...To claim the foreign earned income exclusion, the foreign housing
exclusion, or the foreign housing deduction, you must satisfy all
three of the following requirements.
...Your tax home must be in a foreign country.
...You must have foreign earned income.
You must be either:
A U.S. citizen who is a bona fide resident of a foreign country or
countries for an uninterrupted period that includes an entire tax
A U.S. resident alien who is a citizen or national of a country with
which the United States has an income tax treaty in effect and who is
a bona fide resident of a foreign country or countries for an
uninterrupted period that includes an entire tax year, or
A U.S. citizen or a U.S. resident alien who is physically present in a
foreign country or countries for at least 330 full days during any
period of 12 consecutive months.
So the bottom line for the bond interest income seems to be:
--the income is reportable
--reporting can be deferred until such time as it is "unblocked", but
only if the income is not currently being used for personal expenses
--prevailing exchange rates are used to convert foreign currencies
into US dollars; the IRS apparently makes use of 'official' rates as
posted by banks or embassies. There is no mention of any sort of
--other income from salaries -- so-called foreign earned income -- may
be subject to income tax exemptions.
I trust this information fully answers your question.
However, please don't rate this answer until you have everything you
need. If there's anything more I can do for you, just post a Request
for Clarification, and I'm happy to assist you further.
search strategy -- searched the irs.gov site for [ nonconvertible OR
blocked OR unblocked ]