UPDATED: Tax considerations for Canadians purchasing U.S. real estate

If you are a Canadian who intends to purchase, or who has already purchased, real estate located in the U.S., you need to be aware of the U.S. and Canadian tax issues related to owning U.S. real property. Generally, the first question that arises is: in what manner should the property be held?

Ownership structure

How you choose to structure your ownership will depend on the purpose of the property. Will it be for personal use only, an investment which will generate rental income, or perhaps a mix of both? How long do you intend to own the property? Is your intent to create a legacy asset that is passed to future generations?

Ownership in your personal name is typically the first choice for many Canadians. This is the most straightforward option and the tax treatment upon sale may also be advantageous compared to other forms of ownership. Other options include ownership through a corporation, partnership or trust. Many advisors south of the border, as well as certain information available on the internet, recommend holding U.S. real estate through a Limited Liability Company (LLC). As a Canadian resident, this is generally not the best choice as it can potentially result in double taxation, with income tax rates of up to 70 percent.

Regardless of the reason for purchasing U.S. real estate, it is important to seek professional tax and legal advice in advance of your purchase, as restructuring after purchase can be costly.

U.S. estate tax implications

One significant disadvantage of holding U.S. real estate directly is the possible exposure to U.S. estate tax. The U.S. maintains the right to levy estate tax on Canadians who, at their time of death, own certain assets located in the U.S., called “U.S. situs assets.” U.S. situs assets include U.S. real estate, shares in U.S. companies, and tangible property located in the U.S.

Properly structuring the purchase of U.S. real estate will be a key consideration with respect to U.S. estate tax. Domestic law in the U.S. provides a basic exemption for non-residents of US$60,000. However, the Canada-U.S. Income Tax Treaty allows Canadians an exemption equal to that of U.S. citizens (US$11.7 million). Therefore, as a general rule, Canadians may be subject to U.S. estate tax if they own U.S. situs assets and their worldwide assets exceed US$11.7 million.

Individual taxpayer identification number

If you are a non-resident of the U.S. (and therefore do not have and can not get a U.S. social security number) receiving income from a U.S. property, or are selling U.S. real estate, you are required to obtain an Individual Taxpayer Identification Number (ITIN). An ITIN is a tax processing number issued by the Internal Revenue Service (IRS) used exclusively for helping individuals comply with U.S. tax laws. While applying for the ITIN is not onerous; the application process and required documents that accompany the application is often confusing. Our MNP team can assist non-residents with obtaining their U.S. ITIN number

Earning rental income

If you intend to earn rental income from your U.S. real estate, you will be subject to U.S. income tax on the rental income received. There are two choices in this respect: (1) a tax of 30 percent of gross rental income is withheld and remitted to the IRS (i.e. no deduction for expenses); or (2) make an election to file a non-resident U.S. tax return and pay tax at graduated rates on net rental income (deduction for expenses allowed). Note that as a Canadian resident, the rental income is reportable and taxable in Canada, with an adjustment for foreign exchange.

Sale of the U.S. property

Similarly, when you or your Canadian entity sells the U.S. property, you are required to report this on a U.S. federal income tax return (and a state income tax return if the state in which the property is located levies income tax) and also on your Canadian income tax return, with an adjustment for foreign exchange. For example, if you purchased U.S. property in 2010 for US$500,000 and sell today for US$600,000, the gain for U.S. purposes is US$100,000 (ignoring selling expenses). However, on your Canadian income tax return you will be reporting a gain of approximately CDN$300,000. The higher amount reflects the adjustment for foreign exchange, as the exchange rate was approximately 1.00 in 2010 compared to 1.32 today (i.e., 1 U.S. dollar = 1.32 Canadian dollars). To avoid double taxation, Canada will generally allow a foreign tax credit for U.S. taxes paid on the rental income or gain from sale of U.S. real estate.

Withholding tax on sale

At the time of sale, the U.S. requires the purchaser to withhold 15 percent of the gross selling price under the Foreign Investment in Real Property Tax Act (FIRPTA) and remit this to the IRS as a federal withholding tax. This federal withholding tax may be reduced to 10 percent (depending on the selling price and the intention of the purchaser for occupancy). It may also be possible to further reduce or even eliminate the withholding tax requirement altogether if the seller can obtain a withholding tax certificate prior to the closing date of the sale. Certificates may be granted when the seller can demonstrate that their ultimate U.S. tax liability from the sale of the property is less than the 15 percent or the 10 percent of the of the selling price. In addition, some states require their own withholding tax (California and Hawaii are notable examples).

Contact

If you have questions about the U.S. and Canadian tax issues related to purchasing and maintaining U.S. real estate, we are here to help. Contact David Cender, CPA, CA, CPA (Illinois), Partner, International Tax Services, MNP at 604.542.6716 or [email protected].