For Canadians contemplating selling their U.S. real estate it is critical to understand the tax implications in both the U.S. and Canada, to avoid unexpected costs and complications. Here’s a comprehensive guide to navigating this process.
U.S. Tax Considerations
Foreign Investment in Real Property Tax Act (FIRPTA)
Under the Foreign Investment in Real Property Tax Act (FIRPTA), Canadian residents (and other non-U.S. residents) who sell U.S. real property are subject to a federal withholding tax. This tax is typically 15% of the gross selling price, but can vary based on specific circumstances:
- Sales under $1 million: The withholding tax is reduced to 10%.
- Sales under $300,000: The withholding tax is eliminated if the buyer intends to use the property as their primary residence.
This withholding is not the final tax. Sellers must file a U.S. federal tax return to compute the actual tax liability, which often results in a lower net tax. Any excess withholding can be refunded.
Withholding Tax Reduction
Sellers can apply for a withholding certificate from the IRS to reduce the amount withheld at the time of sale. However, this process involves additional paperwork and professional fees, which may offset the benefits of reduced withholding.
U.S. Tax Rates
Canadians selling U.S. property that they held for more than a year are subject to a maximum U.S. federal income tax rate of 20% on capital gains. State income taxes vary widely:
- No state income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming
- Highest state income tax: California at 14.4%
Filing Requirements
Regardless of withholding, sellers must file a U.S. federal tax return (and possibly a state tax return) to report the sale. A U.S. Taxpayer Identification Number (TIN) is required. If the seller doesn’t already have a TIN, they can obtain one by applying for an Individual Taxpayer Identification Number (ITIN).
Canadian Tax Considerations
Capital Gains Tax
The sale of U.S. property by Canadian residents results in a capital gain subject to Canadian tax. This gain is calculated based on the increase in value in U.S. dollars, so it is also impacted by the exchange rate. If the Canadian dollar has depreciated relative to the U.S. dollar, the gain may be higher when converted to Canadian dollars.
For example, Canadians who purchased U.S. property around 2010-2013, when the Canadian dollar was at par with the U.S. dollar, might realize a significant foreign exchange gain, potentially around 35% at current exchange rates.
Foreign Tax Credit
Canadian taxpayers can claim a foreign tax credit for U.S. federal and state taxes paid on the gain, reducing the Canadian tax liability. Canada’s capital gains tax rates range from 24% to 36% (based on the proposed capital gain inclusion rate increase after June 24, 2024), depending on the province of residence.
CRA Audit Initiatives
The Canada Revenue Agency (CRA) has increased its focus on Canadians owning and selling U.S. real property. They are enhancing their ability to obtain U.S. real property data to more effectively enforce Canadian tax laws. Sellers should ensure full compliance with both U.S. and Canadian tax obligations to avoid potentially heft fines and penalties.
Next Steps
Given the complexity of these tax rules and the potential for significant financial impact, it is advisable that Canadians selling U.S. vacation properties seek qualified and experienced professional cross-border tax advice. Cardinal Point can assist with both U.S. and Canadian tax issues, ensuring a smooth and compliant transaction. For further assistance, contact Cardinal Point to discuss your specific situation and obtain guidance specifically tailored to your needs.
Conclusion
Selling a U.S. vacation property involves navigating a complex landscape of tax regulations in both the U.S. and Canada. Understanding FIRPTA withholding, U.S. and Canadian tax rates, and the importance of filing the appropriate tax returns can help mitigate risks and optimize financial outcomes. Professional advice is invaluable for ensuring 100% compliance and minimizing tax liabilities.
