Being a U.S. person (subject to U.S. taxes) living abroad can at times be the beginning of a U.S. tax nightmare. This can appear to be quite unfair, especially when one has had a Canadian residence established outside of the U.S. for quite some time. If you are an American citizen or green card holder, it is important to be informed that you are subject to taxes on your worldwide income regardless of your country of residence, be it active income or passive income. In certain cases the Canada-U.S. Income Tax Treaty will provide some relief, but sometimes the Treaty may not cover certain tax aspects, such as: no foreign tax credit available for certain types of taxes paid in another country, or for managing tax situations such as: selling a primary residence or rental property or vacation home.
Since AG Tax specializes in cross-border taxes, we often find that our clients (who are often U.S. persons living in Canada) are taken by surprise when they are informed about the tax consequences of selling their primary residence in Canada. To avoid such surprises, here is brief overview of the tax consequences of being the American owner of a house in Canada.
The Canada Revenue Agency (CRA) Rule for Primary and Secondary Residences
As per the CRA, any gain from the sale of a primary residence is not subject to taxes, provided the house qualifies as a ‘primary residence’ (irrespective of where it is located, even if outside Canada); for which the place needs to be “ordinarily inhabited” by the taxpayer during the period of ownership. The sale does not even need to be reported on the income tax return.
In case the person has a house in Canada and another country, if the foreign-located house fulfills the requirement for a primary residence then the house in Canada will be considered as a secondary house, even if the taxpayer has only one house in Canada.
If the place sold is a secondary residence, used for vacation or recreation purpose only, or rented out, tax is payable on any capital gain.
However, if the property sold was used for a year as principal residence while being let out for the rest of the years, then the capital gain needs to be reported for the years which the residence was not a principal residence by completing Form T2091(IND), Designation of a Property as a Principal Residence by an Individual (Other Than a Personal Trust).
Similarly, if a residence was partially used personally and the other half was let out, the capital gain needs to be divided based on the portion of the house let out and the portion that was personally occupied. Capital gains taxes would be levied on the portion that was let out. If more than 50% of the house is let out, then it does not qualify as a principal residence. Additionally, if every year the owner has been filing the income from the rented portion and claiming the expenses, they cannot claim a capital loss (if any) from the sale of the property.
If there is a capital loss, the loss is not deductible, because losses on personal-use property are not deductible except for listed personal property (LPP) losses, which can be deducted from LPP gains.
Additional Reads:
The Tax Rulings Associated With Selling of Canadian Property by Non-Residents: Part I
The Tax Rulings Associated With Selling of Canadian Property by Non-Residents: Part 2
The U.S. Internal Revenue Service (IRS) Rule for Primary and/or Secondary Residences
The IRS allows an exclusion of $250,000 (USD, $500,000 in case of married filing jointly) of capital gain on the sale of a residence. Taxpayers should qualify for this exclusion if they owned the home and used it as their main home during at least 2 of the last 5 years before the date of sale, the house was not acquired in a like-kind exchange in those 5 years (Click here for more information: Canadian Replacement Property Rules vs U.S. Like Kind Exchanges), and if this exclusion was not claimed in the last 2 years (calculated backwards from the sale date).
At times, if the sale was due to work or health reasons, or due to an unfortunate and unpredictable event, the exclusion may be provided even if the above conditions are not fulfilled.
The above rules apply for the sale of a secondary residence as well, or for a house that was partially used as a home-office, provided it was not being used for business or rental at the time of sale, no income was earned from the space in the year of sale, and in the last 2 out of 5 years the house was used only for residential purpose. Otherwise, just like the CRA, calculations need to be done to divide the capital gain between the portion that was used as residence and the portion that was used as office or let out for rental income.
Tax Consequences When You Are Subject To Both the CRA & IRS
A Canadian citizen owning a residence in the U.S. could claim the principal residence exemption when filing their Canadian tax return if they qualify and pay no taxes on the sale proceeds, even if they are subject to the capital gains tax. If the property qualifies as a vacation property, it would be on 50% of the amount. Also, since Canada taxes are based on residency, if the person does not fulfill the Canadian residency requirement, they would not be subject to Canadian taxes on the sale of the U.S. real property.
In case the Canadian citizen is a qualifying Canadian resident who owns a vacation home in the U.S., they should pay attention to the time period spent in the U.S. to avoid fulfilling the substantial presence test, and monitor the frequency of their U.S. visits since if certain conditions are fulfilled they could be subject to taxes in both the countries on their world wide income (Click here for more information: Sunny Retirement for Snowbirds May Not Be Peaceful Tax-Wise).
A U.S. person (even if residing outside the U.S. for years) with a house in Canada would be subject to U.S. taxes on the capital gain above US$250,000, even if the house qualifies as a ‘principal residence’ in Canada.
If the property is a joint ownership, where one spouse is a Canadian citizen, the other is a U.S. citizen, and there is a total capital gain of US$600,000 from the sale of a principal residence, the amount would be divided equally between the spouses. The share of the U.S. citizen spouse would be reportable in the U.S., and any capital gains tax would be levied on the sum of $50,000 ($300,000 less $250,000 exclusion, provided it fulfils the required conditions).
Conclusion
Terms like ‘ordinarily inhabited’, conditions such as ‘like-kind exchange’, the requirement of using the house for 2 out of 5 years, or keeping a gap of at least two years between the sale of two houses, are trouble areas where problems are most likely to occur. When a Canadian home is jointly owned with one of the spouses being a U.S. person, it is a common recommendation to show the house as owned by the Canadian person only. However, all of the taxpayer’s circumstances need to be taken into consideration as there is never a ‘one size fits all’ recommendation when it comes to taxes. Therefore, it is advisable that if you qualify as a U.S. person and intend to purchase a house in Canada, or already own a house but look forward to selling it in the near future, you should consult a tax professional to strategize the purchase or sale so that any tax burden in the future might be minimized.
AG Tax LLP Can Help
If you wish to discuss the above issue further, or have any tax-related queries or need assistance with tax planning or filing please contact AG Tax. Our tax professionals are highly-experienced with U.S. and Canadian tax laws and can provide you the right guidance to handle your tax situation.
Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to U.S., Canadian, and other international tax laws.
We can assist with:
- Canadian Personal and Corporate tax returns
- Cross Border Taxation and Business Planning
- U.S. Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
