By Dan Roberts, Wolrige Mahon LLP
In recent years, many Canadians purchased U.S. real estate to take advantage of the strong value of the Canadian dollar and the depressed real estate prices in the U.S.
Today, with the substantial decline in the value of the Canadian dollar and the increase in real estate prices in the U.S., many Canadians are now considering whether they should sell their U.S. real estate.
Without proper tax planning, however, the decision to sell U.S. real estate may result in some unexpected tax consequences.
This article discusses the U.S. and Canadian income tax exposure that may exist for Canadians who sell U.S. real estate. It should be noted that U.S. income tax may also be levied at the state level. This article addresses U.S. income tax levied at the U.S. federal level only, so careful consideration should be given to the income tax requirements of the state in which the U.S. real estate is located.
Withholding tax
Generally, any person purchasing U.S. real estate from a Canadian will have an obligation to withhold and remit 10% of the gross sale proceeds (15% if the gross sale proceeds are over US$1 million) to the Internal Revenue Service (IRS). The IRS can enforce this liability against the purchaser if the obligation to withhold is not met, so it is standard practice for a purchaser’s legal adviser or escrow agent to withhold this tax.
An exception to the withholding tax is available where the gross sales price is less than US$300,000 and the purchaser signs a statement attesting to the fact that over the next two years, he or she intends to use the property for personal use at least 50% of the time that it is in use.
Where the above exception is not applicable, the withholding tax requirements may be reduced or eliminated by applying for a withholding certificate from the IRS. The certificate allows the withholding tax to be calculated based on the net gain (the sale proceeds less the vendor’s adjusted cost base of the property), rather than the gross proceeds, and is based on the vendor’s projected maximum tax liability. Therefore, applying for a withholding certificate is generally recommended if the withholding tax is well in excess of the maximum tax liability.
To apply for the withholding certificate, the Canadian will need to file Form 8288-B with the IRS in advance of the sale, together with evidence as to the sale proceeds and the adjusted basis of the property. The IRS is required to act upon a withholding certificate within 90 days after its receipt. If the IRS has not replied to an application for the certificate prior to the closing date, the purchaser is still required to withhold 10% of the sale proceeds (15% if the gross sale proceeds are over US$1 million) and maintain it in an escrow account until a reply is received. Once the IRS replies, the purchaser has 20 days to remit any balance owing to the IRS.
U.S. income tax return
The process described in the previous section constitutes a withholding tax only. When a Canadian chooses to sell U.S. real estate, he or she is required to file a U.S. income tax return to report any capital gain or loss on the sale and to pay U.S. capital gains tax on any profit. Any withholding tax applied at the time of sale can be taken as credit on the U.S. income tax return.
A U.S. taxpayer identification number is required by the Canadian when filing a U.S. income tax return. Individuals will need to obtain a taxpayer identification number by completing Form W-7, “Application for IRS Individual Taxpayer Identification Number.”
Canadian companies and other entities selling U.S. real estate will need to apply for an employer identification number by completing Form SS-4, “Application for Employer Identification Number (EIN).”
Canadian income tax return
A Canadian will also need to report the sale of U.S. real estate on his or her Canadian income tax return in Canadian dollars. Where the U.S. real estate is sold for a gain, 50% of the capital gain will be included in income.
In determining the amounts to report in Canadian dollars, the U.S.-dollar sales proceeds and U.S.-dollar cost amount must be converted into Canadian dollars using the exchange rate on the date of the respective transactions. Consequently, depending on when the Canadian purchased the U.S. real estate, the Canadian may have to report, and pay tax on, a significant foreign exchange gain.
Canadians are generally able to claim any U.S. taxes paid as a credit against their Canadian taxes payable.
Conclusion
A Canadian owner of U.S. real estate will be subject to U.S. tax and/or compliance on the sale of the U.S. real estate. Canadian taxpayers who ignore the rules may be subject to significant income tax liabilities and penalties where proper procedures are not followed.
The foregoing provides a practical overview of the income tax requirements for Canadian owners of U.S. real estate. Further information can be obtained from Wolrige Mahon Chartered Accountants LLP at www.wm.ca.
The information provided in this publication is intended for general purposes only. Care has been taken to ensure that information herein is accurate; however, no representation is made as to the accuracy thereof. The information should not be relied upon to replace specific professional advice.
