Tax implications for Canadians owning property in the U.S.

Michael Callahan, CFP®, CIM®

James Smeaton, CPA, CPAC

Do you love the warm sunshine and find the Canadian winter cold and unpleasant? Like many Canadians, you may want to spend the winter months in a sunnier, warmer climate. When many Canadians reach a point in their life where they have the financial resources and flexibility to do so, they consider buying a condo in the U.S. to spend the winter months. A common consideration to help cover the costs is to rent it out when they're not using it, and then sell after a few years. What do Canadian snowbirds need to be aware of?

Canadians who spend significant amounts of time in the U.S. or purchase U.S. real estate should be aware of a few important tax considerations.

Are Canadian snowbirds in the U.S. required to pay taxes?

U.S. citizens, permanent residents, and individuals who meet certain residency tests (including green card holders):

• Can be considered U.S. persons by the U.S. Internal Revenue Service (IRS) for tax purposes,
• Are taxed by the U.S. on their worldwide income (income earned from any place or any source), and
• Are responsible for completing all required U.S. tax filings in a timely manner.

U.S. persons (U.S. citizens and resident aliens) are considered U.S. tax residents and taxed by the U.S. regardless of the location of their permanent residence. Non-U.S. persons could potentially be considered U.S. tax residents if they meet the Substantial Presence Test (SPT). The SPT looks at the number of days an individual was present in the U.S. pro-rated over a three-year period and if the total is greater than 183 days the individual could meet the SPT and potentially be considered a tax resident of the U.S.

Closer Connection Exception

Canadians who meet the Substantial Presence Test (SPT) may be able to use the Closer Connection Exception to remain a non-resident of the U.S. for tax purposes. The Closer Connection Exception requires that an individual:

• Was present in the U.S. less than 183 days in the calendar year,
• Maintains a tax home (prominent place of business, employment, or where an individual permanently lives) in Canada for the entire year,
• Has a closer connection (permanent home, social connections, driver's license location, where registered to vote, etc.) to Canada, and
• Had not taken steps towards and did not have an application pending for lawful permanent resident status (green card).

If these Closer Connection Exception conditions are satisfied, then a Canadian may remain a non-resident of the U.S. for tax purposes. They would still be taxed by the U.S. on their U.S.-source rental income earned, but not their income earned in Canada or any other country.

Do Canadians pay taxes on U.S. real estate?

While there generally aren't any restrictions on Canadians owning real estate in the U.S., there are a number of considerations for Canadians to consider before purchasing real estate in the U.S. For instance, Canadians have additional income tax reporting requirements when the cost of their foreign property, including U.S. real estate used for rental purposes, exceeds CAD $100,000 at any time during the year. You should speak with your advisor and consult a qualified cross-border tax accountant before considering a purchase.

How do U.S. estate laws apply to Canadians?

For non-U.S. persons, an estate tax is levied on U.S. situs assets, which include the assets that are located in the U.S. or have a U.S. connection such as U.S. real estate and shares of U.S. corporations that exceed USD $60,000. However, one of the benefits of the Canada-U.S. tax treaty is it provides Canadian residents with potential tax credits that can reduce their U.S. estate tax liability if certain criteria are satisfied. Even if no tax may be due, a U.S. estate tax return must be filed with the IRS if the deceased Canadian resident, who was not a U.S. citizen, owned U.S. situs assets with a fair market value of greater than $60,000 USD at death.

Do Canadians pay taxes on U.S. rental income?

By default, gross rental income from U.S. properties received by Canadian U.S. non-residents is subject to a 30% withholding tax.

A one-time election can be made to treat the income as effectively connected with a U.S. trade or business. If this election is made a non-resident earning U.S. rental income could be taxed at marginal rates based on their net rental income. However, different rules apply if the property is used personally for part of the year, and some expenses may need to be pro-rated based on personal use. A U.S. non-resident income tax return may need to be filed each year to report the rental income. Also, depending on the state in which the property is located, a separate state tax return may need to be filed as well.

Canadian tax residents are also responsible for reporting their worldwide income in Canada. As such, net rental income from a U.S. property must be reported in Canada as well. However, any U.S. federal and state taxes can typically be claimed as a foreign tax credit in Canada, which results in the Canadian tax liability being reduced by the amount of taxes paid in the U.S., thereby avoiding double taxation.

Tax implications of eventual sale of U.S. property

Canadians are subject to the Foreign Investment in Real Property Tax Act (FIRPTA) rules. Under the FIRPTA rules, Canadian residents who sell U.S. real estate are generally subject to a 15% withholding tax on the gross proceeds of the sale. Note that exceptions to the 15% withholding tax exist if:

• The property has a realized sale price of USD $300,000 or less, and
• The purchaser of the property, or their family member, plans to reside at the property for 50% of two years following the sale.

Note that there may also be additional state withholding requirements depending on the state in which the property is located. Furthermore, when selling the property, U.S. non-residents must also have a valid U.S. ITIN (Individual Tax Identification Number).

Bottom line

Canadian snowbirds who spend time in the U.S. or purchase U.S. real estate can incur significant U.S. tax obligations and be subject to specific filing requirements. Before proceeding, you should speak with your financial advisor and consult with appropriate cross-border tax and legal professionals regarding your intentions to spend time in in the U.S. or invest in U.S. real estate.