Even with the Canadian dollar weakening, there are still plenty of attractive real estate prices in the U.S., and many Canadians are investing there. However, if you’re thinking about buying U.S. property, it’s a good idea to factor in the U.S. and Canadian tax implications, especially if you’re planning any personal use of the new property. This article focuses on the tax implications of buying U.S. real estate personally.
For individuals, income from certain U.S. investments such as real estate is subject to U.S. tax even if you are not a U.S. citizen or resident. U.S. investments are usually taxed in three ways:
• on the income they generate
• on their sale (or gift), and
• on the death of the owner.
Generally, you’ll also have to report rental income and capital gains from your U.S. property on your Canadian tax return. You can generally claim a foreign tax credit in Canada for the U.S. tax you paid.
For example, say you buy a property in Arizona (certainly a “hot spot” — pun intended). You rent out the property in 2015 for US$10,000 in rent. Your mortgage interest, maintenance costs, property taxes, and depreciation total US$8,000 for the year.
Normally, a tenant must withhold 30 per cent of the rent ($3,000) and remit it to the IRS. You can eliminate this withholding requirement by giving the tenant or agent a special form stating that you will file a tax return and pay U.S. tax on your net rental income (rather than gross). Some states (such as California) also impose a withholding tax. Once you elect to pay U.S. tax on your net rental income, this election will apply to all of your U.S. rental real estate both currently and in the future.
At the end of the year, you must file personal U.S. non-resident federal and state tax returns, and pay U.S. federal and state tax on your net rental income of US$2,000 (that is, $10,000 rent minus $8,000 expenses). If the tenant did withhold tax, you can then request a refund to the extent that the withholding tax exceeds the tax owed.
If you have U.S. property for investment purposes, you should file returns even if you have a rental loss so you can carry the loss forward to offset future income and to make sure you claim your deductions, including depreciation. However, if your U.S. property is used only for personal purposes (e.g., a vacation home that you don’t rent) there is no need to file a U.S. tax return until you sell, gift or bequeath the property.
If you do decide to sell your U.S. property, you’ll usually have to pay a federal withholding tax of 10 per cent of the sale price. You must also file a U.S. tax return to report the sale for income tax purposes. If the tax withheld is more than the U.S. income tax you owe, you can get a refund for the difference. State tax (including withholding) may also apply.
One option to potentially reduce the federal withholding tax is to apply for a “withholding certificate” with the IRS before the sale if you expect your U.S. tax liability will be less than 10 per cent. This could certainly help your cash flow. Also remember that a loss realized on personal use property is not deductible for Canadian or U.S. tax purposes.
If you still own your U.S. property when you die, U.S. federal estate tax may apply. In addition, if you choose to gift your property to someone while you are alive, U.S. gift tax may apply. Since both situations can give rise to complicated U.S. and Canadian income tax issues, professional advice can be beneficial.
Although owning U.S. property can be a profitable investment, don’t forget to pay careful attention to your tax obligations and take advantage of opportunities to help reduce your tax liabilities on both sides of the border. Unfortunately, it is not just a simple transaction where you can buy it, use it, sell it, and spend the difference.