U.S. Income Tax: US Taxes are a complicated matter, add in CRA tax returns and how both relate to the US/Canada tax treaty and everything said below must be taken as a starting point ONLY. You absolutely need to seek the advice of a qualified and licensed tax professional/chartered professional accountant that specializes in cross-border tax issues or you run the risks of double taxation and losing significant money by not structuring your investment based on your situation. This article is only a brief overview related to Canadians generating income from U.S. real estate and should not be considered tax advice. I AM NOT a tax professional and don’t play one on TV!
As a non-US resident making money from US assets, you are still subject to income taxes in the US. Generally, the US Internal Revenue Service (IRS) will tax you just like they would any other US person. You will have the same tax bracket rates and be taxed based on the income you derive from within the US only*. There are 7 federal tax brackets ranging from 10% up to 37%, and BONUS if you purchase a home here in Florida, Florida has ZERO income tax on individuals.
*Unless you are considered a “tax resident”. Rules are complex about what can make you a US tax resident, but as a general guideline, you do not have to worry about this unless you are in the US for more than 2 to 3 months every year over a 3-year period (or more than 6 months in any one year). If you are, you will want to consult with a cross border tax planner to ensure you maintain a “closer connection” to Canada and file the proper paperwork to avoid the US taxing you on your worldwide income.
When You Buy
When you purchase a US property in your personal name (not in a corporation), the first thing you want to do is apply for a US tax ID number if you don’t already have one. A tax professional can do this for you as part of the tax plan that works for you or you can apply by filling out a W-7 form and sending to the IRS (www.irs.gov/forms-pubs/about-form-w-7).
If you don’t own the home in a corporation, the tax ID number (referred to as an ITIN) is going to allow you to elect to have your rental income be considered “effectively connected income” and avoid a required withholding of 30% of your GROSS income to the IRS with no offset for any expenses. If you do have your ITIN, you can simply fill out form W-8eci (https://www.irs.gov/pub/irs-pdf/fw8eci.pdf) and have $0 withheld. You still have to file and pay any taxes you owe on your NET income (with this election you get to deduct expenses as any other property investor can), you just won’t have the income withheld based on your GROSS as it comes in.
While You Own
So, we’ve established that If you set yourself up properly, you will not have to have any of your rent income withheld and that the IRS is going to tax only your US sourced income just like they would a US resident. With the assistance of a tax professional (preferably a cross border specialist!) you will also be able to take advantage of all the tax saving strategies that come with owning real estate. In many cases, this means that you won’t owe a loonie in U.S. income taxes (but you still need to file!) while still receiving a healthy cash flow. If you do happen to pay any U.S. taxes, with the U.S.-Canada tax treaty, any taxes you pay in the US may be applied as a tax credit toward your tax bill in Canada. Avoiding being taxed twice on the same income.
Check out “Tax Advantages of Investment Homes” (Coming Soon) for an overview of how tax advantaged real estate investing is in the US. As well as “U.S. and Canadian Cross-Border Taxes Simplified” for an easy way to look at US/Canadian tax relationships.
While you own then, just follow these main points:
- Keep track of all your income before expenses (your property manager should keep these records and send you a statement at the end of the year)
- Keep track of and save receipts of all expenses related to your property (again your property manager should have these files, but it is a good idea to get a copy to save yourself as some managers are more organized than others!)
- This Includes not just expenses like maintenance, property taxes, insurance, interest, management costs, etc, but also things like travel to Florida to find and/or visit your property. Consult with your tax adviser for additional expenses you may be able to use to reduce your tax liability.
- ALWAYS file your taxes with the IRS every year, even if you do not show a profit.
When You Sell
When you sell a property that you have held for 1 year or more, your taxes due will be subject to capital gains tax. Capital gains, just like in Canada, are taxed differently than ordinary income. However, where in Canada you only pay taxes on half the gain, in the U.S. you pay on the entire gain but at a lower tax rate.
In general, if you are in the lower few tax brackets, your capital gains tax rate could be as low as 0%, but in most cases the rate will be 15%. If you have significant income however, the top capital gains rate is 20% (as of the writing of this article 2018). There is a caveat to this however, while you held the property, you should have been taking a depreciation expense against rental income. Know that there is a “depreciation recapture” tax on the amount you depreciated over the years, and that rate is based on which income tax bracket you are in the year of the sale. This is why many people decide to sell when they are in retirement or otherwise find themselves in a lower tax bracket one year.
Here is where things differ for you as a Canadian resident vs. a U.S. resident. Upon sale, you will be subject to a law that is referred to as FIRPTA. This law is strictly enforced and states that anyone purchasing a home from a foreign person, or assists with the sale, must withhold at least 15% of the total sale price from the seller and submit that money to the IRS. You as the seller can file your taxes as normal at the end of the year and wait for a refund of the over-payment this withholding will cause. This can deprive you of tens of thousands of dollars for several months, even up to a year, while you wait for a refund.
There is a way to speed this process up though! You will need your tax accountant to figure out the estimated amount of US tax owed and submit a form 8288-B to the IRS, applying for a “withholding certificate”. The certificate is basically a letter from the IRS that says to the buyer and everyone assisting with the sale, that only a certain amount of money is going to be owed to the IRS, and that they can release all the funds to you the seller, minus the actual amount of tax owed to the IRS. This letter typically takes from 2-4 months to get after the sale of the property.
Keep in mind, the 15% must still be withheld from you at the time of sale. However, it is going to be held in escrow either by the title company that handled the closing (usually), or your own tax attorney. This is much more advantageous than having it held by the IRS. As soon as the withholding certificate comes in, the title company or attorney can release that money to you immediately vs. waiting the months it can take the IRS to send you a refund.
(For more in depth about FIRPTA, check out this article by a cross border tax specialist – https://www.theglobeandmail.com/investing/personal-finance/taxes/article-snowbirds-will-there-be-tax-to-pay-when-you-sell-your-us-property/)
With everything, there are some exceptions to the required FIRPTA withholding. The most common being if you sell a property under $300,000 to an owner occupant you may not need to have 15% withheld. However, do not count on exceptions like this. The practical use of any exception is going to be very limited. Title agents, buyers, attorneys and your real estate agent are liable to pay your taxes is they mess up FIRPTA requirements. So lining up all the parties involved to sign off on not withholding any funds without a withholding certificate form the IRS is rare. If you do a 1031 exchange, you may also not have to deal with a FIRTPA withholding. However, as a Canadian you DO NOT want to do a 1031 exchange anyway (See “Common Advice Canadians Should NOT Listen Too”).
Lastly, even if you have sold all your property in the US and even gotten a withholding certificate from the IRS and paid what they stated you owed in capital gains, you still must file that years’ full tax return even if nothing is owed. (ALTRO Law)
No one wants to think about their own or their significant others’ mortality, but when it comes to owning property in the US, planning can save you and your family a lot of time, aggravation and money should the worst happen.
A quick rule of thumb, if your worldwide assets (do NOT subtract any debts) are under $11 million or $22M if married (at the time this is published) you should not owe any US estate tax if you, your spouse or both of you pass. The US allows for this amount of assets to be exempt from estate taxes (in most cases, again, consult a professional cross-border estate planner!). This amount can be changed by law over time though, just in 2017 the amount was half as much at ~$5M, so you may want to plan for estate tax minimization even if you are under 11M in worldwide assets. Estate taxes in the US can be as high as 40% of the total value of the U.S. estate, so if you have significant US or worldwide assets, planning is crucial.
That being said, there are other issues you should consider in addition to estate taxes. Probate, incapacitation, and liability issues are separate considerations that need to be planned for. Powers of attorney, wills, trusts and entity structure are all things that need to be balanced out and coordinated to sync with not just Canadian and US laws, but also Florida laws as well. Contact us for referrals to professionals that can assist with this (online referral list coming soon).