Capital Gains – Canadians Selling U.S. Real Estate
The housing market in the U.S. has skyrocketed over the past few years due to shortages in the supply of homes, increasing demand, and rising interest rates. As a Canadian resident and U.S. non-citizen owning American real estate, you might have considered selling your foreign property.
American real estate sales carry both Canadian and American tax implications. With proper tax planning and preparation, you can save money and avoid double taxation or the risk of potential complications with the CRA and IRS. Here’s a guide on how to can best prepare for the sale of your U.S. real estate.
A Capital gain is defined as the profit earned in a capital asset’s value which has increased during the holding period up until the time of its sale. To calculate a gain or loss, you must deduct the cost of your net proceeds from the sale of the property from the original purchase price. As part of the net sale and purchase costs, you should consider investments in capital improvements over the duration of ownership (e.g., re-roofing, landscaping, renovations, home additions, etc.), as well as any acquisition costs (e.g., legal or realtor fees, title charges, etc.).
The formula should look something like this:
Net Sale of the Property (including Acquisition Costs) – Net Purchase Price (including Investments in Capital Improvements + Acquisition Costs) = Capital Gain/Loss
If the final number is negative, it is a capital loss. If it is positive, it is a capital gain.
All owners of American real estate must pay income tax on the capital gains of their property sales. Unlike Canada, where only half of your capital gains are taxable, in the U.S., your capital gains tax rate is determined by various factors such as:
- How long you’ve owned the property:
- Up to 365 days: considered short-term ordinary income which is taxed at a normal rate;
- 1 year +: considered long-term income which is taxed at a capital gains rate;
- Your tax bracket which is determined by your total U.S. income, as well as your filing category (i.e., single, married filing jointly, or head of household):
- Short-term capital gains range from 10% to 37%;
- Long-term capital gains are 0%, 15% or 20%;
- Whether the property was used as a vacation home or principal residence.
When filing your American taxes, you must complete Form 1040NR U.S. Non-resident Alien Income Tax Return with the IRS to determine the total amount payable as capital gains on the sale of the property.
All vendors of U.S. property are required to pay income tax on the gains of their property sales. For Canadian residents, the disposition of U.S. real estate is subject to a withholding tax under the Foreign Investment in Real Property Act (FIRPTA). The rate of withholding tax is currently 15 per cent (10 per cent for dispositions before February 17, 2016) of the amount realized on the sale.
The withholding tax isn’t necessarily a tax, rather it is held against capital gains so that the U.S. government can ensure you meet your tax obligations to the IRS. Thus, once your returns have been processed by the IRS, you will likely have the balance refunded to you.
To file your U.S. tax returns, you will need to apply for an Individual Taxpayer Identification Number (ITIN) by submitting a Form W-7 Application for IRS Individual Taxpayer Identification Number which will be used to verify your identity.
The purchaser of your property must act as a withholding agent to collect and remit the tax to the IRS on or with a Form 8288 U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests and Form 8288-A Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests.
Exemptions to the Withholding Tax
In some instances, you may be exempt from the FIRPTA withholding tax. These exceptions are outlined below.
- Personal Use
If the purchaser of your property verifies (often through the commissioning of an affidavit) their intention to reside in the home for two years after the sale, and the sale price is:
- between $300,000 and $1,000,000 U.S. dollars, the withholding tax may be reduced to 10%;
- under $300,000 U.S. dollars, there is no withholding tax requirement for the seller.
- Withholding Certificate
A seller may also be able to reduce or be exempt from withholding tax if the expected capital gains tax is estimated to be less than the amount of withholding tax. Here, the seller can apply for a withholding certificate by completing a Form 8288-B Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests which must be submitted to the IRS prior to the closing date. In this application, the seller must also demonstrate that the capital gains would be less than the withholding amount. The IRS typically takes 90 days to process this type of request.
It is important to note that the exemption application must be in progress by the closing date. The title agent has the power to hold the entire withholding tax amount is escrow until the IRS provides a response to the application.
- Main Home Exclusion
The main home sale exclusion requires both a residency and ownership requirement. Here, the owner must have acquired title and lived at the home for at least two of the previous five years leading up the sale date. This exclusion can only be used once during a two-year period.
Filing your Canadian Tax Returns
As a Canadian resident, you are required to pay taxes on your worldwide income. Thus, you must include the sale of your U.S. property in your Canadian return.
In 1984, Canada entered into a tax treaty with the U.S. known as the Canada-US Income Tax Treaty for the purpose of preventing double-taxation and fiscal evasion with respect to taxes on income and capital.
Article XIII of the treaty declares that if the gain relates to the sale of U.S. real estate, the U.S. has the primary jurisdiction to tax the income with Canada providing a foreign tax credit for the U.S. taxes paid. Consequently, section 126 of the Canadian Income Tax Act provides a foreign tax credit to Canadian residents which offers a deduction in the taxes payable to the CRA in respect of foreign income or profits.
As a Canadian, you may be eligible to claim a foreign tax credit on any income taxes paid when selling U.S. real estate. To claim this credit, you must complete a Form T2209 Federal Foreign Tax Credits and enter the amount from line 12 onto line 40500 of your Canadian tax return. It is important to note that all foreign income and taxes must be converted to Canadian dollars at the rate on the date of the acquisition.
The CRA requires a substantial amount of supporting documentation to substantiate foreign credit applications, including but not limited to your W-2 information slip, 1040 return, U.S. tax account transcript, and any other applicable documentation. Even with this information, the CRA often challenges roughly 80 per cent of claims. Therefore, speaking to a tax professional to help you navigate the process can be extremely beneficial and alleviate any stress associated with the sale of your U.S. real estate. If you have questions or concerns, give us a call today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.