Be aware of tax rules if U.S. property is ever sold
Given the proximity of Canada to the U.S., it is not surprising that many Canadians own real estate south of the border.
Some, especially those who are retired snowbirds, also spend a good part of the year in the U.S. It is important to understand what the tax implications are when you own or sell your U.S. property.
One issue that needs to be addressed is whether your tax status changes for purposes of the Internal Revenue Code by virtue of your time spent in the U.S. More specifically, are you still considered to be a “non-resident alien” for U.S. tax purposes or have you become a “resident alien” for U.S. tax purposes because you stayed in the U.S. too long?
In the eyes of the Internal Revenue Service (IRS), if you spend less than 31 days in the U.S. during the current year, you are considered to be a non-resident alien.
On the other hand, you will be considered to be a U.S. resident for tax purposes if you meet the “substantial presence test.”
If you spend 183 days or more in the U.S. during the current year, you are considered a resident alien.
If you spend between 31 and 183 days in the U.S. during the current year, you will need to determine the number of days you spend in the U.S. during a three-year period (the current and two previous years) using what is often referred to as the 183-day test.
The 183-day test is calculated by adding the sum of (1) all of the days of physical presence in the United States in the current year, (2) one-third of the days of physical presence in the first preceding year, and (3) one-sixth of the days of physical presence in the second preceding year.
If the total exceeds 182 days, then the substantial presence test has been met, and the individual will be treated as a U.S. resident. If under this test you are considered a resident alien, you can still be treated as a non-resident alien if:
You spend less than 183 days in the U.S. in the current calendar year; you maintain your tax home in Canada during the year; and you have a closer connection to Canada than to the U.S.
The significance of the distinction between resident aliens and non-resident aliens is that:
1. Resident aliens are taxed in the U.S. on income from all sources worldwide, while non-resident aliens are generally taxed in the U.S. on income only from U.S. sources.
2. Resident aliens have to file a U.S. tax return to report worldwide income if their annual gross income exceeds certain U.S. dollar amounts.
Canadian residents who at any time during the year own foreign investment property (called specified foreign property) costing more than $100,000 are required to file the Form 1135 Foreign Income Verification Statement.
Specified foreign property includes real estate situated outside Canada, but does not include personal-use property, that is, any property used mainly for personal use and enjoyment.
Therefore, if you own a condominium in Florida that costs over $100,000, but which is utilized purely for personal use and enjoyment, you would not need to report the condominium on a Form T1135.
However, if the condominium is utilized for personal use for four months of the year and is rented out for 8 months of the year for profit, the property is considered to be an income-earning investment property not held primarily for personal use and enjoyment.
As a result, you are required to report the property on a Form 1135.
When a non-resident alien sells their U.S. real estate, the resulting gain or loss is required to be reported to the IRS by filing Form 1040NR.
The purchaser is required to withhold 10 per cent of the gross sale price if the sale price exceeds US$300,000. Withholding is not required where the purchaser acquires the property for use as a residence and the sale price is US$300,000 or less.
The tax normally required to be withheld on a disposition can be reduced or eliminated if you obtain a withholding certificate from the IRS. The IRS will issue the withholding certificate if the amount required to be withheld would be more than the maximum tax liability.
Therefore, if you expect the tax liability on the sale of your U.S. property to be less than 10 per cent of the gross sale price, you should request the withholding certificate and file it before the closing date of the sale. The certificate, if granted, will specify the amount of tax to be withheld instead of the full 10 per cent.
On the Canadian side, a taxable capital gain may also result from the sale of the U.S. property.
A foreign tax credit is generally available with respect to related U.S. tax paid to eliminate double taxation.
It may also be possible to claim the principal residence exemption for all or part of the gain on the sale. However, careful consideration should be made here, because if there is no Canadian tax payable, the U.S. tax paid will not receive a tax credit in Canada.
Remember also that the gain or loss arising from foreign currency fluctuations between the time the property was purchased and its sale will be factored into the computation of the Canadian gain or loss.