Source: Benita Loughlin, Financial Post Published: Friday, March 05, 2010
With the Canadian dollar above US90¢ and real estate prices in the United States at a historical low, successful Canadian entrepreneurs who may have surplus funds in their business or may even have sold it may be planning to invest in U.S. property.
Business owners who may be weighing the costs and benefits of purchasing a condo or home, or other U.S. property such as shares, must remember to factor in any applicable U.S. taxes.
Business travellers to the United States have the opportunity to see places first-hand. Although business owners should be familiar with U.S. business tax rules, they may not necessarily know about personal tax rules.
Generally, income from certain U.S. investments, including real estate, is subject to U.S. tax even if you are not a U.S. citizen or resident. U.S. investments are usually taxed in three ways: on the income they generate, on their sale or gift, and on the death of the owner.
There are complicated U.S. and Canadian tax implications business owners need to consider if they plan to buy U.S. property through their company, especially if they plan to use the asset personally. However, this article focuses on the tax implications of buying U.S. property personally.
But if you are a business owner who, planning ahead to retirement, decides to buy a condo in say, Arizona, and rent it out. Assume you receive US$10,000 in rent in 2010 and our mortgage interest, maintenance costs, property taxes and depreciation total US$8,000.
A 30% withholding tax normally applies to rent paid to a Canadian resident for real estate in the United States. As such, your tenant should withhold 30% of the rent paid to you, or US$3,000, and remit it to the Internal Revenue Service. That can be eliminated by giving the tenant or agent a form that states you will file a tax return and pay tax on the net (rather than gross) rental income. You must file a personal U.S. tax return, separate from any business returns, by the end of the year. U.S. tax on the net rental income income in the example would be US$2,000 ($10,000 rent minus $8,000 expenses). If the tenant withholds tax, you can receive a refund, to the extent the withholding tax exceeds the tax payable. State tax (and possibly a small amount of city or county tax) may also apply to U.S. rental income.
Once you elect to pay tax on net rental income, this election will apply to any U.S. rental real estate you hold now and in the future.
You should file a return even if you have a rental loss so you can carry the loss forward to offset future gains and to claim your deductions, including depreciation, which is not a discretionary deduction (in fact, it will reduce the cost base of the property even if you don't claim it).
If you decide to sell your condo, a withholding tax of 10% of the sale price normally applies under the Foreign Investment in Real Property Tax Act of 1980. You must also file a U.S. tax return to report the sale for income tax purposes. If you realize a capital gain on the sale and the FIRPTA tax
withheld is more than the U.S. income tax you owe on the capital gain, you can get a refund for the difference. Again, state tax (including withholding) may apply.
You may be able to reduce the FIRPTA withholding by applying to the IRS before the sale for a "withholding certificate" if your expected U.S. tax liability is less than 10% of the sale price.
You must also report rental income and capital gains from your U.S. condo on your Canadian tax return. You can generally claim a foreign tax credit for the US tax you paid to reduce your Canadian tax.
When you're considering selling U.S. real estate, remember the U.S.-Canadian exchange rate will affect the amount of a capital gain taxable in Canada because the cost of the property is converted to Canadian dollars at the exchange rate at the time of purchase and the proceeds are converted at the exchange rate at the time of the sale.
If you still own your condo when you die, U.S. estate tax may apply. This tax was repealed for 2010, but it will be reinstated for 2011 (and possibly some or all of 2010) and will continue to impose a potential burden on the estates of Canadians who own U.S. real estate and other property. Some states also have their own estate taxes.
There are ways to reduce your estate's potential U.S. tax. However, this type of tax planning is complicated and professional advice is advisable.
If you choose to give your condo to a family member during your lifetime rather than in your will, U.S. gift tax will apply. You may also have to pay Canadian tax if a capital gain has accrued, but no foreign tax credits are allowed in Canada for U.S. gift tax. Due to the different tax treatment of gifts in Canada and the United States, gifting real property in the United Staets is rarely advisable. Tax consequences are different for other types of U.S. property.
Like rental payments, dividends and interest paid by U.S. corporations to Canadian residents are subject to U.S. withholding tax. The Canada-U.S. tax treaty limits the tax to 15% for dividends and zero for interest in most cases. You do not have to file a U.S. tax return to report dividend income on which the correct tax has been withheld or for interest that is exempt from U.S. income tax.
When you sell your shares in a U.S. corporation, Canadian tax will apply to any capital gain but U.S. tax will normally not apply as long as you are not, nor have been, a U.S. citizen or resident. U.S. tax may apply if the shares are in a private company with a majority of its value derived from U.S. real estate. U.S. gift tax does not apply to gifts of U.S. securities
by Canadians even though U.S. estate tax may apply to them.
Tax implications should not discourage Canadian entrepreneurs from buying property in the United States. If you pay careful attention to meeting your tax obligations and take advantage of any opportunities to reduce U.S. liabilities, you can reap the benefits of owning the property while minimizing your costs.