US real estate owned by Canadian residents

If you’re a Canadian resident who receives rent from US real estate, you’re normally subject to a US withholding tax of 30% of the gross amount of any rent paid. As an alternative, you can elect to pay tax on the US rental income you receive on a net basis. In this case, you must file a US tax return at the end of the year, reporting your net rental income. By making this election with the IRS and providing appropriate information to the tenant, the 30% withholding tax is not required. Once you make this election, it’s permanent and can only be revoked in limited circumstances.

Many people mistakenly assume that because their expenses always exceed their rental income, there’s no need to file a US tax return or to have tax withheld at source. The IRS requires that a withholding agent (such as a real property manager who collects the rent on behalf of the non-US resident) be personally and primarily liable for any tax that must be withheld from the rental income. If the non- resident fails to submit a timely filed return, not only will the withholding agent be liable for outstanding amounts, interest and penalties, but also the non-resident will lose the ability to claim deductions against the rental income causing the gross rents (instead of net rents) to be subject to the 30% tax.

In addition, unlike Canadian tax rules, depreciation is a mandatory deduction in the US. If you don’t file a return, you’re still deemed to have claimed depreciation and could be subject to recapture. Failure to file a tax return also reduces your ability to carry forward passive activity losses since the IRS has no record of them. As a result, on a subsequent sale of the property, you would have a taxable income inclusion in the form of recapture with no offsetting loss carry-forward.

Tax tip: Professional advice should be obtained if you receive rental income from US real property and have not filed a US tax return because your expenses exceed your rental income.

Selling your US property

Effective February 16, 2016, US Federal legislation has increased the withholding tax rate from 10% to 15% of gross proceeds on the sale of US real property if you are not a US person. There are certain exceptions to this rule. For example, this withholding won’t apply if the property is sold for less than US$300,000 and the purchaser intends to use the property as a residence. If the property is sold for an amount greater than $300,000 but less than $1,000,000 and 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. Also, you can apply to the IRS to have the withholding tax reduced if the expected tax liability on the sale will be less than 15% of the sale price.

Regardless of the amount of withholding tax, the gain on the sale of any US property is still taxable in the United States and a US tax return must be filed. The 15% withholding is applied against the tax balance owing in the US. If the tax is less than the 15% withheld, you’ll receive a refund for the difference. You should ensure that you apply for a US Individual Taxpayer Identification Number (ITIN) as part of the withholding tax process to ensure the tax gets properly credited to your account with the IRS.

The US tax paid on the sale generates a foreign tax credit that can be used to reduce the Canadian tax payable on the sale. If you’ve owned the property continuously since before September 27, 1980 for personal use only, there’s a provision in the Canada-US tax treaty that can be used to reduce the gain. In such cases, professional advice should be sought.