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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.

What Every Canadian Snowbird Should Consider Before Buying a “Nest” in the U.S.

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When it comes to real estate, it’s been said that the three most important words are: location, location, location. For southern-bound Snowbirds, owning a home in the U.S. offers the opportunity to return to a favorite place each year, a home away from home. This allows you the certainty of knowing where you will spend your vacations and how many of your friends and family can join you there. And as the seasons pass, your vacation home will likely appreciate in value—an incentive to purchase, rather than rent, your winter getaway. If you are considering buying a “nest” in the U.S., you’ll want to take into account two key factors: choosing the right ownership structure and allocating your time across the border.

The time to decide how to structure ownership is before making your purchase. Establishing a Canadian corporation as the legal owner will help avoid U.S. estate taxes; however, rental revenue and capital gains will be taxed at the U.S. corporate tax rate of up to 35%. A Canadian partnership significantly reduces the tax burden of U.S. property that earns rental income, but will be subject to estate taxes. Still other options are setting up a Canadian trust or a hybrid trust. Each type of ownership comes with a different level of tax exposure. For this reason, it’s important to (a) understand the tax implications for you and your family, considering your “world wide” assets, and (b) establish the corporation, partnership or trust before you buy a home in the U.S. With careful planning, you can relax and enjoy your vacation home with peace of mind.

Once the purchase is complete, you will likely want to spend as much time as possible enjoying your vacation getaway. While most of us think of 183 as the magic number—days spent in the U.S. per calendar year—in fact it’s wise to keep the number 3 in mind. The IRS’ “substantial presence” test considers the time you spent in the U.S. over a three-year period, according to this formula:

  • 100 percent of days in the current year; plus
  • 1/3 of days in the prior year; plus
  • 1/6 of days in the second preceding year.

If the average number of days spent per year, over the three-year period, exceeds 183, this may trigger a U.S. tax residency, subject to U.S. taxes. If “substantial presence” is established, you may still have the option to file for a “Closer Connection” exemption with the IRS. Keeping track of your travel dates every year is the best protection.

Of course, our closest connections are with friends and family. With careful planning, a snowbird getaway will be a great place to spend time with your loved ones, year after year.

John McCord is the Director of Private Wealth Services at the Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada. John specializes in providing Canada-U.S. cross-border financial, investment, tax, transition, and estate planning services.

This piece is for informational purposes only.

Same House, Different Tax Rules: Selling a House in Canada

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Cross-border couples often enjoy the best of both worlds: travelling between the U.S. and Canada, experiencing two distinct cultures and exploring the natural beauty unique to each country. Indeed, Canada and the U.S. are different in many ways. For married homeowners in Canada, one important difference is how the U.S. and Canadian tax systems treat selling a home.

capitalgainstax-cp-thumb Let’s take a look at Laurie-Anne and Jack’s story. Laurie-Anne is a Canadian citizen, married to Jack, a U.S. citizen. They had owned and resided together in their home in Montréal for ten years before selling it this year. In a robust market, they sold their house for $380,000 more than they had paid for it.
After the sale, Laurie-Anne and Jack were concerned about tax on their capital gain, so they sought our advice. What they learned is that even though they are splitting the proceeds equally, the tax burden will not be the same for each of them.

As a Canadian citizen, Laurie-Anne will not have to pay tax on the capital gain; Canadian tax law does not require taxation on the sale of a home when it has been the principal residence for the entire duration of ownership. In fact, the couple will not even have to report the sale on their tax return in Canada.

Jack files his U.S. tax returns as “married filing separately.” U.S. regulations require that Jack declare all income—worldwide—including his share of the capital gain on the sale of the couple’s home in Montréal. There is an exclusion that benefits Jack: if he has owned or lived in the home long enough to qualify, he is allowed to exclude up to US$250,000 of capital gains from the sale of the house in Canada.

The same house, sold by the same couple, will be regarded entirely differently depending on which side of the border your paperwork is filed. Knowing your rights and obligations—and how they differ between the U.S. and Canada—can help you hold on to your “gains” as you prepare for your next big investment.

Terry Ritchie is the Director of Cross-Border Wealth Services at the Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada.  Terry has been providing Canada-U.S. cross-border financial, investment, tax, transition, and estate planning services to affluent families for over 25 years.  He is active as an author, speaker and educator on international tax and financial planning matters. www.cardinalpointwealth.com

What Should Canadians Consider Before Purchasing US Real Estate?

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This article outlines financial planning concerns for Canadian buyers who want to take advantage of real estate opportunities in the United States for either financial or lifestyle choices. Author John McCord highlights complex issues such as estate, insurance, financing, residency, immigration and taxation that are important considerations in the purchase of property in the U.S. In addition to potential tax advantages, a unique real estate investment opportunity through the EB-5 visa program also offers the possibility of a streamlined Green Card approval process. To understand the merits and the pitfalls, McCord recommends consulting with a qualified team of professionals who specialize in Canadian and United States cross-border transitioning and asset management in order to develop the best individualized strategy.