U.S. Tax Compliance for Canadians Who Own U.S. Real Property
U.S. Rental income
If a Canadian resident receives rental income from real property located in the U.S., they are subject to a non-resident withholding tax of 30% of the gross rental income, which is required to be remitted to the Internal Revenue Service (IRS) by the tenant. The 30% withholding tax cannot be reduced by way of the Canada – United States income tax convention.
Non-residents of the U.S. can also make an election to be taxed as if their rental income was effectively connected with the conduct of a trade or business in the U.S. Furthermore, the taxpayer can deduct expenses engaged to earn rental income and then be taxed on the net income at graduated rates, rather than a 30% flat rate on the gross rent. To make this election and avoid the 30% withholding, a taxpayer must complete form W-8ECI and provide the form to the person who is paying the rent.
To deduct expenses in order to be taxed on your net income, a taxpayer must file a U.S. tax return as a non-resident (form 1040NR). The amount of the tax withheld will be reported on the 1040NR and will get refunded if there is excess tax withheld over the final income tax liability. The tax return must include a statement confirming that an election has been made. The election must include the address of the property, your percentage of ownership, description of improvements made, etc.
A taxpayer only has to make the election once and the election has to be made on each new property. The election will be valid for as long as a taxpayer owns a property and if their 1040NR is filed on time. To file a 1040NR, a taxpayer will need to obtain a U.S. Individual Taxpayer Identification Number (ITIN) by completing a form W-7.
A taxpayer also has to report rental income in the state where the property is located.
Selling U.S. Real Property
If a Canadian resident sells real estate located in the United States, they are subject to a 10% or 15% withholding tax of the gross selling price under FIRPTA (Foreign Investment in Real Property Tax Act). If the property is sold for an amount greater than $300,000 but less than $1,000,000 and the property is being purchased with the intention of being used as the purchaser’s residence, then the sale will only be subject to a 10% withholding as opposed to the 15% rate. The tax withheld will be offset against the U.S. tax liability on any gain realized on the sale and will be refunded if it exceeds the tax liability.
There are two exceptions to the withholding requirement which can reduce or eliminate the requirement.
- The first exception applies if the property is sold for less than $300,000 USD to a buyer who intends to occupy it as their principal residence. The gain on the sale is still taxable in the U.S. and a tax return (1040NR) must be filed.
- The second exception is if a Canadian resident gets a withholding certificate from the IRS on the basis that the expected U.S. tax liability will be less than 10% or 15% of the selling price. The certificate will indicate the amount of tax that should be withheld by the purchaser rather than the full 10% or 15%. Ideally, the withholding certificate should be obtained from the IRS before the sale closes. To apply for a withholding certificate a Form 8288-B must be completed and sent to the IRS. A U.S. ITIN must be included on the Form 8288-B or can be applied for by way of a Form W-7 with the Form 8288-B. The IRS will generally issue a withholding certificate within 90 days of submission.
The gain or loss on the sale of a U.S. real property by a non-resident is required to be reported on a U.S. Non-Resident Income Tax Return (1040NR). As a Canadian tax resident the disposition of a U.S. property is required to be reported in Canada. If there is a gain on the sale, the U.S. has the right to tax the gain first and the U.S. tax liability can be claimed as a foreign tax credit against any Canadian and provincial tax on the sale.
Similarly, state income tax may apply on the sale depending on where the property is located.
Please contact your DJB accountant should you wish to discuss this further.