In past years, with a strong Canadian dollar, Canadian Snowbirds were able to pick up investment properties or vacation homes in popular locations such as Arizona, California and Florida. With a softer Canadian dollar, snowbirds are finding some competition for these types of homes. Cardinal Point Capital Management’s Terry Ritchie discusses the current state of the U.S. real estate market for snowbirds in this Globe and Mail article.
From the Insurance & Investment Journal article:
Managing cross-border clients is a challenging area for advisors that requires thorough knowledge on how to handle life insurance, investments, taxes and pensions while respecting two countries’ rules and regulations.
The Insurance and Investment Journal spoke to U.S-Canada cross-border expert Terry Ritchie, a director at Cardinal Point Wealth Management, who’s specialized in the field for more than 25 years to find some answers. He says if you don’t have knowledge or experience it is very easy to mess things up for your client.
Our previous article discussed the concept of California domicile and the application of California community-property rules to Canadians domiciled in the state. This article is the second installment in our series explaining how California community property laws can impact Canadians.
At Cardinal Point, we regularly deal with cross-border couples who maintain cross-border lifestyles due to career commitments or other obligations. It’s important to understand how California’s community property laws apply when one spouse is domiciled in California and the other in Canada.
Imagine a married couple in which the wife lives in Toronto (and is domiciled in Ontario) and the husband lives in Los Angeles (and is domiciled in California). Both spouses are dual American and Canadian citizens and they file a joint U.S. Form 1040 tax return. The husband, Drew, is a professional hockey player who plays for a California-based NHL team. Drew’s wife, Amber, is a top fashion model based out of Toronto. The couple owns homes in both Toronto and Los Angeles. Since Amber is mainly working in Toronto, New York, London and Paris, she only spends two weeks a year in Los Angeles with her husband. Moreover, Amber does not earn any California-sourced income.
One might assume that Amber does not need to file a California tax return and pay California tax, given that she doesn’t earn any California income and isn’t domiciled in California.
But as we stated in our previous article, California follows its own rules for determining tax residency. Unlike federal tax treatment, an immigrant to California is normally a California resident from the date of arrival. No 183 physical presence test or green card is required to determine California residency status. Moreover, since California is not a party to the Canada-U.S. tax treaty, the treaty is not applicable for purposes of determining California residency (similarly, California does not allow a foreign tax credit or the federal foreign earned income exclusion).
Going back to Drew and Amber, because they are filing jointly on their federal return, California requires the same joint filing status on their California return, and they would pay California tax on their worldwide income.
There is, however, a little-known legal exception that will allow our imaginary couple to file separately instead of jointly for California tax purposes. To file separately in California, two criteria must be met: (1) Amber must not be a resident of California and (2) she must not have any California-sourced income, including California wages and income from California real-estate property.
With Amber filing separately under the exception, she would still need to file a California 540NR non-resident return to pay tax on 50% of her husband’s California income. That’s because Drew is domiciled in California. Moreover, she would need to disclose her non-California-sourced income on the California return to determine her California tax rate.
Because of the complexities facing cross-border couples, they are well advised to seek out tax advisers who specialize in navigating the cross-border tax landscape.
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. 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.
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?
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.
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.