Several years ago, Canadians were uniquely positioned to benefit from a depressed United States real estate market. Low prices coupled with a strong CAD (Canadian dollar) presented some terrific buying opportunities.
In 2016, our plunging loonie (around $0.71 USD) coupled with a recovering U.S. housing market yet again uniquely positioned Canadian sellers of U.S. property to benefit from both capital appreciation and a favourable exchange rate. Even after accounting for the tax consequences of huge gains, sellers were left with significant returns.
Now that our dollar seems to be on the rise, the margin of gain might decrease compared to last year and it is important for potential Canadian sellers of U.S. property to understand the income tax consequences of a sale. Following are major key concepts with summarized explanations:
Withholding of Tax: In general, any person who purchases U.S. real estate from a Canadian owner is obliged to withhold and remit to the IRS (Internal Revenue Service) 10% of the gross sale proceeds ie: the total value of the sale. (15% if the gross proceeds exceed $1 million US.) The IRS can enforce this liability against the purchaser if the purchaser does not meet this obligation to withhold. The transacting 3rd party (usually an escrow agent; equivalent to notary’s role in Quebec) normally fulfills this obligation on the buyer’s behalf.
Withholding of Tax Exception: Where the gross sale price of the property is less than $300 000 US, an exception to the withholding of tax is available provided that the buyer signs an affidavit attesting that he/she intends to use the property as a principal residence for at least 50% of the time during the 2 years following the purchase.
Withholding Certificate: For cases where the above exception doesn’t apply, the vendor could apply to the IRS for a Withholding Certificate that could reduce or eliminate the withholding of tax. The certificate allows the withholding amount to be calculated on the net gain rather than the gross proceeds (ie: (sale amount) minus (original cost of purchase + any expenses such as renovations; also called the adjusted cost base) = Net Gain.) In advance of the sale, the Canadian would need to file the appropriate form + supporting documents with the IRS and then wait for clearance. For transactions where the amount of tax withheld might significantly exceed the vendor’s projected U.S. tax liability, the certificate is a viable option .
U.S. Income Tax Return: Additional to withholding issues, a Canadian who has sold a U.S. property is required to file a U.S. Income Tax return to report any capital gain or loss on the sale and is liable for U.S. capital gains tax on the profit. Any tax previously withheld is credited against this calculation. A U.S. Taxpayer Identification Number (TIN; essentially the US equivalent of Canadian SIN) is necessary to filing a U.S. income tax return and is obtained by filing the appropriate request form to the IRS. The capital gains tax rate is affected by several factors including the duration of ownership of the property prior to sale.
Important notes: (1) The above information applies to U.S. federal requirements; depending on the state in which the U.S. property is held, additional state income tax requirements may apply. (2) The above information applies to Canadian individuals in ownership of U.S. property; Canadian corporate owners may be subject to different requirements.
Canadian Income Tax Return: Canadians must also report the sale of U.S. property on their Canadian income tax return, in Canadian dollars. The conversion rate used is the exchange rate in effect on both the date of purchase and the date of sale. Hence the grand importance of where our CAD stands versus the USD on both dates. In general, Canadians would be able to claim the U.S. taxes paid as a credit against their Canadian taxes payable.
This information is provided to enhance understanding of the terminology and concepts at play. For more detailed information direct from the IRS, please consult the Foreign Investment Real Property Tax Act (FIRPTA). Any Canadian considering a cross-border real estate transaction should consult professionals appropriately qualified to evaluate both Canadian and U.S. legal and tax ramifications.