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Possible Tax Changes for Snowbirds

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1040thumbWriting about possible U.S. tax changes for Canadians, Terry Ritchie, Director of Cross-Border Wealth Services, appeared in the January 2015 issue of Advisors Edge. In the “TaxBreak” column, Terry summarized how some of the recently enacted changes at the IRS can affect snowbirds.

Though the new U.S. Congress will likely focus its efforts on corporate taxation, there are still a number of newly enacted tax provisions to keep track of. More than 40 changes were enacted by the U.S. Internal Revenue Service in late 2014. A few of the notable changes include: an increase in the standard deduction for singles and married persons; limitations on itemized deductions; and an increase of the basic exclusion amount for the estates of people who die in 2015. Read the full article here.

U.S. Tax on Canadian Rental Property

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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:

  1. Historical cost plus closing costs and improvements; or
  2. 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:

  1. NR6 to avoid being subject to a 25% withholding tax on gross, not net, rental income; and
  2. Section 216 Return to report rental income and expenses for the property; and
  3. 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.

Am I a U.S. tax resident?

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Most Canadians who move to the U.S. have a good understanding of their immigration residency status. However, many do struggle to determine their residency status for U.S. income tax purposes.

While it is common knowledge that U.S. citizens and green card holders are responsible for filing U.S. tax returns, most people who move to the U.S. on a non-resident visa – such as a TN, E1 or E2, O-1, L-1 – are unfamiliar with the U.S. tax residency rules that can subject them to U.S. taxation on their worldwide income.

This is not surprising given that the definition of a resident for U.S. tax purposes is mutually exclusive of a U.S. resident for immigration purposes.

As a result, a non-resident for U.S. immigration purposes, can in fact be a U.S. tax resident who is subject to U.S. taxation on their worldwide income. On the other hand, a non-resident for U.S. tax purposes is subject to U.S. taxation only on their U.S. source income.

To assist our Canadian clients navigate the complicated U.S. tax residency rules, we have prepared the following summary of the most common questions Canadians have when it comes to lodging a U.S. tax return:

How Do I Become A U.S. Tax Resident?
Simply put, if you are physically present in the U.S. for at least 183 days in one calendar year. You can also be considered a resident under the Substantial Presence Test (SPT) if you spend, based on a special formula, at least 183 days in the U.S. during the past three calendar years.

For Canadians who like to visit the U.S. for cross-border shopping, beware because even those short day trips south of the border count as a full day for purposes of the 183 day threshold.

Conversely, a Canadian who is never physically present in the U.S. for more than 120 days in each calendar year will not qualify as a U.S. tax resident.

What Happens if I Become A U.S. Tax Resident?
Since most Canadians moving to the U.S. for work on temporary visas are unlikely to spend less than 183 days in the U.S., they qualify to be taxed as U.S. residents.

Although special rules beyond the scope of this article apply to a first year U.S. tax resident, a U.S. taxpayer lodges a Form 1040 and reports all their worldwide income, including all investment income, capital gains, rental income from non-U.S. rental properties and foreign pension income.

Is There A Way To Avoid Being Treated As A U.S. Tax Resident?
If a Canadian working in the U.S. on a temporary visa qualifies as a non-resident taxpayer, then they lodge a Form 1040NR and generally only pay U.S. income tax on wages earned while working in the U.S.

However, if you qualify as a U.S. tax taxpayer, the following exemptions will allow you to lodge a U.S. return as a non-resident:

1) Closer Connection Exception (CCE)
A Canadian who meets the SPT may avoid lodging a return as a U.S. resident by filing Form 8840.

To qualify to file the Form 8840, one must meet all the following criteria:

  1. Have a “tax home” (usually where your family, permanent home and personal belongings are located) and a closer connection to Canada
  2. Be physically present in the U.S. for under 183 days in the current calendar year; and,
  3. File form 8840 to indicate this connection on a timely basis (filing this form late may cause you to be ineligible to claim the CCE)

2) Non-Residency Under The Treaty
In the event a Canadian working in the U.S. on a temporary work visa is physically present in the U.S. for at least 183 days in a single calendar year, it is still possible to avoid U.S. residency by filing a Form 1040NR with a Form 8833 treaty election.

Generally, a treaty election is used when a taxpayer is considered a tax resident of both the U.S. and Canada. In the case where a taxpayer is a simultaneous resident of both the U.S. and Canada, the treaty acts as a tiebreaker to determine which country has the right to tax the taxpayer as a resident.

The U.S.-Canada tax treaty contains a provision that allows a U.S. taxpayer to be treated as a Canadian tax resident, and hence a U.S. non-resident, if Canada is their permanent home.

If a taxpayer has a permanent home in the U.S. and Canada, then it’s necessary to look at where a taxpayer maintains their center of vital interests, their habitual abode and their citizenship to break the tie.

Nevertheless, a person who uses the treaty to be taxed as a U.S. non-resident is still considered a U.S. tax resident for other filing purposes. As such, Canadians need to report their financial accounts and interests in foreign corporations, trusts and partnerships to the IRS on the following forms:

  • Foreign Bank Accounts (FinCen 114)
  • Foreign Corporations (5471)
  • Foreign Partnerships (8865)
  • Foreign Trusts (3520/A)

Tax filers beware as fees to prepare these foreign compliance forms can be costly because they are complicated and time consuming.

Does California Follow The Same Residency Rules As The IRS?
Sadly, if lodging a federal return in the U.S. wasn’t complicated enough, a whole set of different rules beyond the scope of this article apply to determine if a Canadian working in California is considered a California tax resident, and hence subject to California tax on their worldwide income. Since California is not a party to the U.S.-Canada tax treaty, no foreign tax credits can be taken for any foreign taxes paid to Canada. In addition, since California is a community property state, special California community property tax rules apply with respect to splitting community income.

In Closing
Because few tax professionals work with Canadians temporarily working in the U.S., it is important to partner with a firm that understands the tax complexities involved in cross-border employment. At Cardinal Point, we assist Canadians working in the U.S. on temporary visas and are available to assist with properly assessing your U.S. tax residency and preparing the necessary U.S. and Canadian tax filings.

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.

Terry Ritchie, U.S. Expatriation and Your Dual Citizen Clients

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In this video, Terry Ritchie speaks with InvestmentExecutive.com’s Rudy Mezzetta about what U.S. citizens living abroad need to know when considering renouncing their U.S. citizenship. Though the numbers of expatriations are reaching historical highs, the process is not an easy one. After filing with the Department of Homeland Security, an individual wishing to renounce citizenship must meet with the consulate. Upon approval, the individual will be issued a CLN: Certificate of Loss of Nationality, from The State Department. This is not a quick process.

In terms of taxes, if you meet one of these rules—a worldwide net worth of $2 million or more, average annual net income tax of more than $150,000 (adjusted for inflation), or have not complied with all U.S. tax responsibilities in each of the five preceding years—you can be defined as a “covered expatriate.” CEs are subject to onerous tax considerations, including a “mark-to-market tax” that takes into account what you would net if you sold all of your assets upon expatriation, and then taxes this amount as a capital gain. Further implications include a tax on qualified assets and tax-deferred investment vehicles.
Finally, Terry reveals the #1 reason that Americans chose not to expatriate: the possibility (based on pending U.S. legislation) of not being allowed to return to the U.S. View the video here.

Advising same-sex couples with U.S. ties

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Terry Ritchie, Director of Cross-Border Wealth Services, was recently featured in an article from Advisor.ca looks at how a recent ruling from the U.S. Supreme Court opened the door to new planning options for same-sex partners with ties to the U.S. The June decision struck down a key part of the Defense of Marriage Act and broadened the federal definition of marriage to include legally married same-sex couples. The new definition also applies to American couples who marry outside the U.S.

Following the decision, the IRS released the tax implications: “Same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes. The ruling applies to all federal tax provisions where marriage is a factor.” The article goes on to give examples of how advisors can help their clients benefit from these changes, specifically in the areas of tax filing, wealth transfer, and principal residence exemption. Read the full article here.