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It is no surprise many Canadians moving to the U.S. choose to rent out, rather than sell, their properties back home. With a strong rental market and housing price valuations in cities like Toronto and Vancouver, the return on investment from keeping and renting the property is attractive.
Unfortunately, becoming a non-resident of Canada and conversely becoming a U.S. tax resident, while leaving a rental property behind, creates tax filing complexities not only in the U.S. but also in Canada.
How Do I Report a Foreign Rental Property In the U.S.?
Reporting Income and Expenses
If you own a rental property in Canada and you are filing as a U.S. tax resident, the rental income must be reported on Schedule E of your U.S. tax return. For U.S. tax purposes, the allowable expenses you can claim against the rental income are generally the same as in Canada although under U.S. tax law, it’s mandatory to claim depreciation, even if the property is negatively geared (more on this later).
Adding further complexity is the need to generally translate all your income and expenses from Canadian dollars to U.S. dollars on the date of each transaction.
On the bright side, you can take a tax credit against your U.S. federal income tax for income taxes paid to Canada on your net rental income. That credit is limited to the amount of U.S. Federal tax you paid on the rental income on your U.S. tax return. Sadly, for California residents, no tax credit is allowed for income taxes paid to Canada, essentially resulting in a double tax.
How do I Determine My U.S. Tax Cost Basis?
Determining your U.S. tax cost basis in a foreign rental property can be tricky, especially if it will be difficult to breakout the value of the property between the land and building component. As such, sometimes it may be necessary to hire a surveyor to assist with ascertaining the valuation of the property to comply with U.S. tax law.
Generally, the U.S. tax cost basis subject to depreciation of a foreign rental property is the lower of:
- Historical cost plus closing costs and improvements; or
- Fair market value (FMV) on the date the property is placed into service for U.S. tax purposes
For a lot of our Canadian ex-pat clients, given the housing booms back home, the FMV of the property is not usually applicable.
Therefore, we are normally left using the historical cost of the property that needs to be converted into U.S. dollars at the exchange rate in effect at the time the property was purchased.
For those of you thinking of selling the property, beware, because this means the U.S. can tax you on the full gain on the sale of the property, including appreciation of the property that occurred prior to you becoming a U.S. tax resident. Even worse, for Canadians who bought their properties a decade or more ago, the U.S. will also tax you on the foreign currency gain attributed to the increase in the Canadian dollar. We’ll have more to say on the tax consequences of selling your property as a U.S. tax resident later.
Besides adjusting the cost basis for exchange rate purposes, an additional adjustment may need to be made to reduce the property’s cost basis by the U.S. depreciation that would have been allowed under U.S. tax law for all the years prior to a Canadian becoming a U.S. tax resident.
How Do I Depreciate My Foreign Property?
In our experience, the one mistake we regularly see made on returns for taxpayers with a foreign rental property is the depreciation method used. While U.S. tax law generally allows a U.S. residential rental property to be depreciated over 27.5 years, for foreign properties, depreciation is computed using a 40 year straight line method under the Alternative Depreciation System (ADS).
What if My Property Is Negatively Geared?
Under the U.S. tax code, losses from passive activities, such as foreign rental properties, normally cannot be deducted from income. Nevertheless, an exception exists for taxpayers with a modified adjusted gross income below $100,000 that allows up to $25,000 of rental real estate loss to be deducted against ordinary income, such as wages, provided you “actively participate” in the rental activity (basically you are involved in meaningful management decisions regarding the rental property). This exemption is phased out for taxpayers whose modified adjusted gross income exceeds $100,000 and is eliminated entirely when it exceeds $150,000.
What if I Want to Sell My Foreign Property?
There can be a silver lining for most Canadians who sell their foreign properties after becoming a U.S. tax resident. If the property was used as your personal primary residence for the 2 years during the previous 5 years prior to sale, you may be able to exclude up to $500,000 ($250,000 if single or married filing separately) of the gain from your U.S. income taxes under the exclusion allowed for sales of personal residences.
How Do I Report My Rental Property As a Non-Resident of Canada?
Canada
The detailed Canadian tax rules for reporting a non-resident owned Canadian rental property is complex and beyond the scope of this article. We’ll be publishing a separate article on this topic in the near future.
However, in short, a non-resident of Canada with a Canadian rental property will want to annually file the following forms with CRA:
- NR6 to avoid being subject to a 25% withholding tax on gross, not net, rental income; and
- Section 216 Return to report rental income and expenses for the property; and
- NR4 Return/Slip to report the gross rental income and Part XIII withholding tax.
In case you are wondering, you are not able to claim the Section 45(2) election as a non-resident.
In Closing
While complying with the various tax rules for a Canadian rental property can be difficult, the cross-border tax specialists at Cardinal Point are available to provide assistance with the tax filing requirements in the U.S. and Canada.
Marc Gedeon is a CPA (U.S), CPA (Canada) and Tax Attorney at Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada. Marc specializes in providing Canada-U.S. cross-border financial, tax, transition, and estate planning services. www.cardinalpointwealth.com This piece is for informational purposes only and should not be considered legal or tax advice. Online readers should not act upon this information without seeking professional counsel.
