The Income Tax Implications of Selling U.S. Real Estate

Many Canadians own U.S. real estate, especially winter vacation properties. If you own such a property, the income tax consequences can be very complex. Some people erroneously think they are subject to double tax on the sale of their U.S. property, which is not true. Today I will review some of the issues

in relation to the sale of a U.S. property.

Let’s assume you purchased your U.S. vacation property for $200,000 USD several years ago when the exchange rate was $1.10. Thus ignoring legal and other acquisition costs, your Canadian cost base of the property is $220,000 Cdn. Let’s also assume you have just sold your Miami property for $325,000 USD or approximately $420,000 Cdn.

U.S. Withholding Tax Issues

I am not a U.S. income tax specialist, so if you are selling, confirm the following with a U.S. accountant. However, as I understand the process, one of the first things you need to do is obtain a US Individual Taxpayer Identification Number (ITIN), if you don't already have an ITIN or Social Security Number. The ITIN is obtained by filing a Form W-7, and the application is generally filed concurrently with the first U.S. federal tax form you are required to file, which could be either a tax return or a withholding tax form.

If you sell your vacation property for less than $300,000 USD and the buyer intends to use the property as a “residence” for more than half of the time it is used in the 2 years after purchase, you should be able to obtain an outright exemption from any tax withholding. The buyer would simply be required to sign an affidavit as to their intended use of the property.

If you sell for more than $300,000 USD, you will generally be subject to a 10% FIRPTA withholding tax on the gross proceeds. In this example, the tax would be $32,500 USD. But this is not the final determination of tax. A 1040NR U.S. non-resident tax return should be filed to report the actual gain. You can apply the $32,500 USD withholding tax against any tax owing or if your actual U.S. tax liability is less than the amount withheld, you may be entitled to a refund.

However, there is another means to potentially reduce or eliminate the withholding tax. On or before the closing date, one can file an application for a withholding certificate via Form 8288-B. This would reduce the withholding tax from 10% of the gross proceeds to 20% of the actual capital gain (which is the theoretically maximum amount of tax that could be owing). If the certificate is not received by the closing date, the transfer agent or lawyer handling the sale would hold the 10% default tax in escrow until such time that the certificate is received from the IRS, at which point the reduced withholding (if any) would be remitted to the IRS, and the excess funds would be released to the seller.

U.S. Tax Filing Issues

You must file a U.S. 1040NR to report the disposition of your property, regardless of whether or not income tax was withheld, or whether the property was sold at a gain or a loss. Continuing with our example, you would report a capital gain of $125,000 USD ($325,000 USD proceeds less $200,000 USD cost) on the U.S. tax return. If we assume the actual U.S. income tax owing is $15,000 USD (just an assumed tax number for this example), you would receive a refund from the IRS of $17,500 USD ($32,500 USD withholding less $15,000 USD tax owing).

As noted above, many Canadian think they are double taxed. That however is not the case. Any U.S. tax paid becomes eligible for what is known as a foreign tax credit (FTC) in Canada. The final result should be you never owe double tax, but that you are taxed only once, albeit at the higher rate of the two countries.

Canadian Filing Issues

As a Canadian resident, you are taxed on your worldwide income. For Canadian tax purposes, you would have a capital gain of $200,000 Cdn ($420,000 Cdn proceeds less $220,000 Cdn cost). Let’s assume the income tax on this capital gain is $50,000 Cdn. On your Canadian return you will claim a FTC of $20,000 Cdn (rounded equivalent of $15,000 USD actual US tax) against the $50,000 Cdn and as consequence, you will owe an additional $30,000 Cdn in Canadian income tax.

If you add the US tax paid ($20,000 Cdn) to the $30,000 Cdn actual Canadian income tax, you will note that you will have paid $50,000 Cdn in combined tax to the IRS and the CRA. The $50,000 Cdn in total tax is the same amount as the capital gains tax in Canada. So you have not paid tax twice, just once at the higher Canadian tax rate.

The sale of a U.S. property is very complex; please consult a US and/or Canadian tax advisor before you sell to understand the compliance procedures and income tax consequences of your property sale.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Income Tax Preparation Tips

As promised last week, here is a summary of the Tax Tweet Tips I posted last year (in many cases, expanded from the 140 character limit imposed by Twitter). I have updated these tips to assist you in preparing your 2013 personal income tax return

Tax Tips for Preparing your 2013 Return

1. If you sold stocks or real estate in 2013, ensure you have the original cost documents. 

Note: This issue is twofold. Firstly, you should always maintain stock purchase confirmations or the annual summary to substantiate the adjusted cost base of any stock purchases. You also must maintain the original reporting letter and statement of adjustments for any real estate purchase. Secondly, many people do not keep receipts (or they may have paid cash) to substantiate cost base additions to their rental properties or cottages. Without these documents, you may have a difficult time convincing the CRA that the adjusted cost base of your real estate is higher than the original purchase price.

2. Confirm your 2013 installment payments online. Alternatively, there is a summary of the 2013 installments you paid on the back of the 2014 installment reminder the CRA just sent you.

3. Interest expense related to your investment accounts is often missed. Check the bottom left of your T5 summary for the interest you paid during the year.

4. If you sold collectibles in 2013, such as coins, stamps and china, they may not be taxable if your proceeds were <$1,000.

5. Canadian residents who are also US citizens or Green Card holders must file a 1040 US return. If you are a Canadian resident earning Rental Income in the US, you must file a 1040NR.

6. Do you own shares in any delisted, bankrupt or insolvent companies? You may be eligible to file an election to claim the capital loss this year.

7. When filing a deceased parent/grandparent’s return, ensure you report any deemed dispositions of stocks or real estate.

Note: Upon passing, if property is not transferred to a surviving spouse, the deceased taxpayer is deemed to have disposed of their capital property at death as if they actually sold the shares or real estate. The determination of the cost base of that property can often be problematic to say the least.

8. File returns in the year your child turns 18.They may be eligible for some claims at 18 and others at 19 are based on their age 18 return.

9. If you sold capital property in 2013 that was held prior to 1994, review whether you elected to bump the value in 1994.

Note: In 1994 the $100,000 capital gains exemption was eliminated. However, you were entitled to make a final election to use your capital gains exemption on stocks, real estate etc. Many people forget they made such an election and that their cost base on certain property is higher, which reduces the capital gain to be reported. This election was used extensively by people on their cottages. So if your parents sold their cottage in 2013 remind them to check if they made the election in 1994.

10. Do you pay investment counsel fees to an investment advisor? If so, they are deductible.

11. If you have a Line of Credit for investment purposes, check your December, 2013 statement for a summary of the interest you paid in 2013 & claim the interest expense that related to your investments (you may have to apportion that expense if you co-mingle your LOC with personal expenses).

12. Did you own foreign property with a cost of over $100,000 at any time during the year? If so, you must file Form T1135.

13. If you sold a US stock in 2013, use the F/X rate from the year of purchase to determine the cost and use the 2013 rate for the proceeds. You have two choices. Either use the actual F/X rate on the day of purchase and sale, or you can use the CRA's yearly average rate however, you must be consistent.

14. Did you sell a REIT in 2013? Reduce the ACB by the return of capital from prior years.

15. Last tip. Don’t file your return late no matter what! There’s a 5% penalty + another 1% per month up to 12 months. Even if you cannot afford to pay the tax due, file your return to avoid the penalties. You can usually make arrangements with the CRA to pay off your tax liability over time if you provide reasonable terms of repayment.

Hiring The Blunt Bean Counter

This is the time of the year when I’m frequently asked by readers of The Blunt Bean Counter to provide individual tax preparation services. While it is truly is an honor to receive these types of inquiries, my tax practice at Cunningham is focused on corporate tax, estate planning and financial advisory.

Unfortunately, these days, Chartered Professional Accountants only have about 3-4 weeks to complete the majority of our personal income tax returns, because most of our clients T-slips do not arrive until early April. This circumstance has forced me to narrow the scope of my tax compliance practice and I typically reserve the time I do have available to prepare personal tax returns for the owner-managers of the companies that I service. Consequently; I am unable to take on any additional personal income tax return work for non-corporate clients.

I am actively taking on new corporate clients and welcome direct company inquiries and referrals. My contact information is noted on the right-sidebar, just above the little trophy.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.