Due to the close proximity, many U.S. individuals move to Canada for personal or work reasons but maintain their U.S. citizenship. In addition, some Canadians acquire U.S. citizenship from one or both of their parents. As U.S. citizens, the person needs to fulfill their U.S. tax responsibility. This includes reporting the sale of a Canadian or U.S. principal residence or vacation properties.
Since homes and other real estate properties are often considered ‘long-term assets’, many individuals tend to hold on to this asset for a future sale when they are in need of money or when they have decided to liquidate their assets to fund retirement or other major financial goals.
This practice, often leads to a significant difference between the cost/purchase price and the prevailing fair market value (FMV) for the property, especially since the U.S. and Canadian real estate market has been booming.
Unfortunately, this can lead to a severe capital gains tax burden upon sale of the property, which often comes as a surprise to many individuals who are subject to both: U.S. and Canadian taxes.
The following is a brief overview by A.G. Tax cross-border tax professionals on the taxation of a U.S. real estate property sold by a U.S. Citizen residing in Canada
Please note that this article is for information purpose only. In case a taxpayer is facing a similar situation, it is highly recommended to consult a tax practitioner for tax advice based on one’s personal tax situation.
Difference Between Capital Gains Taxation in U.S. & Canada
Principal Residence Taxation
In Canada, if a house, whether Canada-situs or foreign, qualifies as a ‘principal residence’, any capital gain from the sale of the house will not be subject to taxes under the ‘Principal Residence Exemption‘ regulation. To qualify as a principal residence, the taxpayer must reside in the property during the year and designate the property as his principal residence for the year. The property does not have to be the taxpayer’s main home as long as he or his family occupy it at some time during the year.
In the U.S., the IRS provides for an exclusion of up to $250,000 for single, and $500,000 for married filing joint on any capital gain from the sale of a residence. Any gain that is above the threshold limit would be subject to taxes, regardless of whether the property is U.S.-situs or foreign.
To qualify as a principal residence for U.S. tax purpose, an individual must have owned and used the home as his main home for two of the last five years.
As a result, if the U.S. citizen, currently residing in Canada, waits too long after arriving to Canada (more than 5 years) to sell their U.S. residence they may not even qualify for any of these exemptions. For Canadian tax purposes also, the individual would be taxed on the gain after his move to Canada since the property would not qualify as a ‘principal residence’ if the taxpayer does not ordinarily reside in that particular residence.
Taxation of Vacation Property or Other Properties That Does Not Qualify As ‘Principal Residence’
If the house sold is not a ‘principal residence’, any capital gain from the sale of a house would be subject to capital gains tax. Both U.S. and Canada offer preferential tax treatment of capital gains but the rules in each country differs. In Canada, only 50% of the capital gain is taxed using the individual’s marginal tax rates. The U.S. Internal Revenue Service (IRS) will tax 100% of the capital gains, however, the tax is calculated at special lower capital gain rates.
At times, Taxpayers are not aware of these taxation differences and limitations. If a taxpayer does not prepare or plan for the sale, it could lead to a significant capital gains tax burden. A further complication may exist if the sale is qualified for principal residence treatment in one country but not the other.
Tax Situation: Canadian Resident and U.S. Citizen Selling Their Canadian Residence
If a Canadian resident and U.S. citizen/person sells his Canadian (non-U.S.) principal residence at $750,000 CAD, which was purchased at $200,000 CAD, the capital gain on the sale is $550,000 CAD.
Since the house is a qualifying principal residence, and the individual is a Canadian resident, the capital gains will not be taxable in Canada.
The U.S. IRS tax liability is calculated on the capital gains after deducting the adjusted cost basis (i.e. property purchasing cost, improvements or renovations cost, and any advertising costs incurred to sell the property) and exemption (if qualifying) from the sale proceeds. In addition, amounts must first be converted to U.S. dollars based on the conversion rates prevailing during the time of purchase and sale to arrive at the accurate capital gain amount.
Assuming, an exchange rate of 1 CAD = 0.75 USD when the property was purchased and 1 CAD = .80 when sold, the cost basis will be $150,000 and selling price will be $440,000. The gain for U.S. purposes would be $290,000. As this exceeds the $250,000 exemption, the taxpayer will be subject to U.S. tax on $40,000 of taxable capital gain. If the taxpayer is in the highest U.S. tax bracket, the tax on the capital gain would be 20%.
No foreign tax credit (FTC) can be claimed as the individual did not pay any taxes on the capital gains in Canada.
When the Residence Does Not Qualify As ‘Principal Residence’
Now, if the house did not qualify as a principal residence in Canada, nor does the non-resident U.S. citizen qualify for the U.S. exemption, the tax consequences in both the countries will be as follows:
In Canada, the taxpayer will be subject to Canadian capital gains tax on 50% of the capital gains, i.e. $275,000. Assuming the person’s income falls in the highest Canadian tax bracket, the Canadian capital gains taxes owed will be approximately $110,000. (This would vary depending on the taxpayer’s province of residence)
The U.S. tax liability, assuming the highest U.S. tax bracket, will be $58,000 (20% of $290,000). A foreign tax credit can be claimed in the U.S. for the Canadian tax paid. In most cases, the tax paid to Canada would offset U.S. taxes owing, however, there are instances where this is not the case.
Let’s say the property was bought when the Canadian dollar was low (0.60) and sold when the Canadian dollar was high (.90). The taxpayer paid Canadian $400,000 for a property (US$ 240,000) and sold it for $300,000 (US$270,000). As you can see, the taxpayer will have a loss in Canada of $100,000, but a gain in the U.S. of $30,000. As a result, he will be required to pay U.S. tax on the sale even though he has a loss for Canadian purposes.
NOTE: The above examples do not take into consideration any tax credits, deductions that the individual may qualify for, nor does it take into consideration the U.S.-Canada tax treaty. While considering a real life situation, significant and proper planning is required before selling the property to minimize one’s tax liability.
Conclusion
With the absence of FATCA, individuals, earlier, managed to avoid complying with their U.S. tax responsibility. However, with the U.S. passing the FATCA regulation and signing agreement between U.S. and other foreign countries to share the financial information of their respective taxpayers it is likely that the IRS will obtain the information from the individual’s bank if not by the individual himself. If the amount is significant and one-time, the IRS could doubt it to be some form of sale proceeds and work towards obtaining further details.
U.S. citizens in Canada often fail to realize that they need to comply with their U.S. tax responsibility even as Canadian residents. Additionally, even though a tax treaty exists, income from all sources need to be reported to avoid incurring future expenses in the form of taxes, interest on unpaid taxes and penalty for unpaid taxes and unreported income.
Having said that, there is also a possibility of change to the existing taxation of only 50 per cent of the capital gains from the sale of a real estate in Canada in the 2017 Federal Budget.
Consulting a U.S. Canada tax expert can minimize the possibility of tax errors, and help reduce the tax burden by planning the sale of the principal residence, vacation property, or any other property.
AG Tax LLP Can Help
If you have any queries related to taxation of U.S. properties sale proceeds, or other 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., Canada and other international tax laws.
We can assist with:
- Canadian Personal and Corporate Tax Returns
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Please contact either of our offices in Canada at 604-538-8735 (Greater Vancouver), or 780-702-2732 (Edmonton and Alberta) to arrange for an appointment to discuss your tax related queries.
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