U.S. and Canadian Income Tax Implications on the Sale of Your Personal Residence

When it comes to selling a personal residence, taxpayers in both the United States and Canada benefit from considerable exemptions that can shield all or part of the gain from capital gains tax. However, individuals who have cross-border status—particularly U.S. citizens living in Canada—face unique and sometimes costly tax implications. Below is a comprehensive discussion of the rules in each country and an illustrative example based on a U.S. citizen couple selling their Canadian home for a gain of more than $500,000 (USD).

United States: Principal Residence Exclusion

For U.S. tax purposes, the Internal Revenue Service (IRS) offers taxpayers a principal residence exclusion on capital gains from the sale of their home. The rules are as follows:

• Ownership and Use: To qualify, the seller must have owned and lived in the home for at least two out of the five years preceding the sale.
• Exclusion Amount: Up to $250,000 of gain can be excluded for single filers, or $500,000 for married couples filing jointly.
• Portion Above Exclusion: Any gain above the exclusion amount is taxable as a capital gain and must be reported on the tax return, even if the home was located outside the U.S.
• Reporting Requirement: Even if you exclude the full gain, if you receive an IRS Form 1099-S (Proceeds from Real Estate Transactions) or cannot exclude the entire gain, you must report the sale.
• Multiple Sales: The exclusion is generally available once every two years and only for your principal (main) residence.

Tax Rates: The taxable portion is subject to long-term capital gains tax rates, which can reach up to 20%, plus a 3.8% net investment income tax (NIIT) for high earners.

Canada: Principal Residence Exemption (PRE)

Canada’s tax system is generous regarding the sale of a primary home:

• Principal Residence Exemption (PRE): Most Canadians selling a home that has been their principal residence for every year of ownership can exempt the entire capital gain from taxation.
• Eligibility: The taxpayer, their spouse, or dependents must have “ordinarily inhabited” the home during the year for which the exemption is claimed.
• Designation Requirement: Homeowners must designate the property as their principal residence on their tax return using CRA Schedule 3 and CRA Form T2091(IND).
• Sales After Jan 1, 2023: If you held the property for less than a year (365 days), the gain may be treated as business income (and subject to full taxation) unless an exemption applies (e.g., death, divorce, work relocation).
• Multiple Properties: Only one property can be designated per family unit per year.

In summary: for most Canadians, there is typically no capital gains tax on a qualifying principal residence.

Complications for U.S. Citizens in Canada

Double Tax Liability: U.S. citizens are taxed on their worldwide income, even while residing abroad, so a U.S. citizen living in Canada must report the home sale to both the IRS and the Canada Revenue Agency (CRA).

• Canadian Tax: The gain is often fully exempt due to the PRE.
• U.S. Tax: The gain above the $500,000 (joint) exclusion is taxable, regardless of its status in Canada.
• Foreign Tax Credits: U.S. citizens may be able to claim a foreign tax credit for taxes paid to Canada to mitigate double taxation, but if no tax is owed in Canada due to the PRE, there is no foreign tax to credit. The U.S. tax liability is therefore generally unavoidable on the portion exceeding the exclusion.

Example: U.S. Citizen Couple in Canada with Large Gain

Scenario:
A married U.S. citizen couple who have lived in Montreal, Canada, for over 20 years purchased a home for $500,000 CAD. They sell their home in 2025 for $2,000,000 CAD. The exchange rate is 1.30 CAD/USD (for simplicity).

• Purchase Price (USD equivalent): $500,000 / 1.30 = ~$384,615
• Sale Price (USD equivalent): $2,000,000 / 1.30 = ~$1,538,462
• Capital Gain (USD): $1,538,462 – $384,615 = $1,153,847

Canadian Treatment:

• The entire gain is tax-free under the principal residence exemption if the home was their principal residence for every year owned.

U.S. Treatment:

• Compute the gain for U.S. tax: $1,153,847
• Apply the married exclusion ($500,000): $1,153,847 – $500,000 = $653,847 taxable capital gain for U.S. tax.
• Tax Rate: Up to 20% long-term capital gains tax; likely plus 3.8% Net Investment Income Tax (NIIT).
• Estimated U.S. tax liability:
  • Capital gains tax (20%): $653,847 × 20% = ~$130,769
  • NIIT (3.8%): $653,847 × 3.8% = ~$24,845
  • Total estimated U.S. tax: ~$155,614

They cannot claim a foreign tax credit because no actual Canadian tax was owed due to the PRE. As a result, this U.S. citizen couple would face a significant U.S. tax bill on the sale—despite the transaction being fully exempt in Canada.

What if only one of the spouses was not a U.S. citizen – For U.S. citizens living in Canada, capital gains on the sale of a principal residence can trigger U.S. tax once gains exceed the U.S. $250,000 exemption. A planning opportunity exists where the U.S. citizen spouse transfers their ownership interest in the Canadian home to the Canadian (non-U.S.) spouse. Since the Canadian spouse is not subject to U.S. capital gains tax, this strategy can eliminate the U.S. tax exposure on future appreciation while still preserving Canada’s principal residence exemption. This would constitute a taxable gift and the requirement by the U.S. citizen spouse to file a U.S. gift tax return – IRS Form 709 for any gift that would exceed the 2025 annual exclusion of $190,000 to their non-citizen spouse.  If the principal residence is now held by the non-U.S. citizen spouse upon sale, U.S. capital gains would no longer apply to the U.S. citizen spouse.

Key Takeaways and Planning Pointers

• U.S. citizens living in Canada face unique challenges—the U.S. home sale exclusion does not fully shelter large gains on foreign principal residences if those gains exceed $500,000 (joint).
• Canadian PRE is more generous: it may exempt the entire gain regardless of size, whereas the IRS sets a hard-dollar cap.
• Tax Planning: Explore options such as timing the sale, spousal transfers (in some cases), or deferring income to manage capital gains exposure. However, the “U.S. tax shadow” always follows U.S. citizens abroad.
• Reporting: Always report the sale appropriately on both Canadian and U.S. returns, completing all necessary forms and designations.
• Consult professional tax advisors like those at Cardinal Point to coordinate cross-border planning, as tax treaties and credits can be nuanced in application.

In summary:
Selling a principal residence in Canada is typically tax-free for Canadians, but U.S. citizens must grapple with the U.S. capital gains regime, including reporting and paying tax on gains above the IRS exclusion—often with no offsetting Canadian tax paid. Strategic planning and understanding the rules in both jurisdictions are essential to avoid unexpected tax bills and comply fully with both countries’ authorities.