Canadians Selling U.S. Vacation Property
Canadians need to know how the U.S. and Canada will tax the sale of U.S. vacation property, particularly in light of CRA’s recent audit initiative on Canadians owning and selling U.S. real property.
Canadians that own U.S. vacation property look forward to winter when they can spend time in their sunny second homes. The Covid-19 pandemic has dramatically changed plans for those not willing to put themselves and their families at risk by travelling to the U.S. Some are willing to sit and wait, others don’t see themselves returning to the U.S. for years and plan to sell their beloved U.S. real property.
Residents of Canada selling U.S. real property need to understand how the U.S. and Canada will tax their sale. Failing to do so may result in frustration and unnecessary costs arising from U.S. tax rules on the sale of U.S. real property by Canadians and other non-resident aliens of the U.S. This blog does not address Canadian residents who are also U.S. citizens or tax residents of the U.S. (U.S. persons).
U.S. Withholding Tax
Canadian resident individuals are subject to the U.S.’s Foreign Investment in Real Property Tax Act (FIRPTA). It subjects sellers, who are not U.S. persons, to U.S. federal withholding taxes of up to 15% of the gross selling price of the U.S. real property. This tax is not the final U.S. tax. It is credited against the final U.S. federal tax liability. Any excess U.S. federal tax withheld is refundable upon filing a U.S. federal tax return computing the actual tax due. The U.S. tax return computes the net gain or loss which is often lower than FIRPTA tax withheld on sale.
The seller can reduce the FIRPTA withholding tax by applying for a clearance certificate from the Internal Revenue Service (IRS). It requires additional documents and professional fees. Any benefits of reducing the tax withheld may be eliminated from the professional costs of obtaining a clearance certificate.
The FIRPTA withholding tax is 10% for homes sold for less than US$1 million. It will be eliminated on sales of less than US$300,000 where the buyer plans to use the home for their primary residence.
California and Hawaii also impose withholding taxes on sales of real property in their states by non-residents.
U.S. Tax Rates
Canadians that hold U.S. real property for longer than one year are subject to a maximum U.S. federal income tax rate of 20%. State income tax rates can add anywhere from 0% (Alaska, Florida, Nevada, South Dakota, Texas, Washington, Wyoming) to 13.3% in California. Arizona’s top marginal income tax rate is 4.5%.
U.S. Individual Taxpayer Identification Number
Regardless of whether U.S. federal or state taxes are withheld at closing, the seller is required to file a U.S. federal and, if applicable, state income tax return to report the sale of their U.S. real property. Filing the U.S. tax return(s) will require the seller to have a U.S. taxpayer identification number which may be either a U.S. Social Security Number or Individual Taxpayer Identification Number (ITIN), something sellers may not have. A seller may apply for an ITIN on the sale of their U.S. real property. An ITIN isn’t required to close the sale of U.S. real property and can be obtained when filing the annual U.S. federal income tax return. Failing to obtain an ITIN at closing may delay the IRS matching the FIRPTA tax withheld at closing to the U.S. tax computed the U.S. tax return.
The sale of U.S. real property may result in a capital gain subject to Canadian taxes that is much higher than expected. Not only is any real gain in U.S. dollars subject to Canadian tax, any appreciation of the U.S. dollar against the Canadian dollar is also subject to Canadian income tax as a foreign exchange gain. Canadians who purchased U.S. real property when the Canadian dollar was at par with the U.S. dollar around 2010 to 2013 may realize a foreign exchange gain of approximately 35% at current exchange rates.
Any U.S. federal or state income tax liability computed on the U.S. tax returns filed can be claimed as a foreign tax credit to reduce Canadian taxes otherwise payable on the related gain. Canada’s highest capital gains tax rates range from 24% to 27% depending on the seller’s province of residence.
Canada Revenue Agency recently announced a search for a group to provide it with U.S. real property data with a goal to enhance its ability to administer tax programs and enforce Canadian tax law. More information on CRA’s audit initiative on Canadians owning and selling U.S. real property can be found here.
Andersen Tax LLP can help sellers with their U.S. and Canadian tax issues, questions and tax returns. Please contact us if you are selling U.S. real property.