With the Canadian dollar weakening and the price of U.S. real estate rising, many Canadians who have previously purchased U.S. real estate may now be tempted to sell. Those who purchased after the epic U.S. real estate meltdown may walk away with a hefty profit. However, it is important for every Canadian who is considering disposing of their U.S. real estate investment to be aware of certain key U.S. and Canadian tax issues in order to avoid any nasty surprises the result of which may turn the hefty profit into something less. The following are some of the issues for a Canadian resident planning to sell personally-owned U.S. real estate, assuming the individual is not a U.S. citizen or otherwise a U.S. person:
1. You need to get a U.S. Individual Tax Identification Number (“ITIN”)
The IRS requires that individuals obligated to pay a U.S. tax, but ineligible to obtain a social security number, obtain a nine-digit “ITIN.” The IRS will generally not issue an ITIN to a person unless they can demonstrate a need for the number (such as a U.S. tax filing obligation). In order to obtain an ITIN, a foreign individual can either mail to the IRS a completed Form W-7 along with supporting documentation which would often include that individual’s original passport or submit the form through an “Acceptance Agent”. Canadian taxpayers that have been earning rental or other income will hopefully have either a social security number or ITIN which they have been using to comply with previous years’ U.S. tax obligations.
2. U.S. Foreign Investment In Real Property Tax Act (“FIRPTA”) withholding
Since persons who are not U.S. citizens are generally beyond the reach of the IRS for purposes of determining and collecting U.S. tax obligations, the U.S. tax regime imposes a number of procedural “safeguards” on transactions involving foreign persons to ensure the U.S. treasury is not being “short-changed” with respect to tax on U.S. sourced gains or income. As such, when a foreign taxpayer sells a real property interest, a purchaser (or their agent) is generally required to withhold and remit to the IRS 10% of the gross sales proceeds. The withholding requirement itself can add some complexity to a transaction. A complete or partial exemption from the 10% FIRPTA requirement may be granted by the IRS if the seller provides information to the IRS proving that the ultimate tax liability on the sale will be less than the 10% tax withheld.
3. U.S. tax filing due dates and obligations
A foreign seller must file a U.S. income tax return for the year of sale to report gain or loss. The 10% FIRPTA withholding can be used to offset the tax liability on the gain. In many cases, the 10% FIRPTA is greater than the tax liability and a refund is the end result of filing the return. Generally speaking, a foreign individual is required to file and pay U.S. taxes prior to June 15 of the subsequent calendar year.
4. Canadian capital gain
A resident of Canada is subject to Canadian income tax on worldwide income including capital gains from the sale of U.S. real estate. It is important to note that any capital gain must be calculated in Canadian dollars, so both proceeds and cost amounts need to be converted into Canadian dollars at the exchange rate applicable on the transaction date. Thus, someone who acquired property when the Canadian and U.S. dollars were at par and sells the property when the Canadian dollar falls to 0.90 U.S. dollar is subject to Canadian tax on the 10% foreign currency gain, even if there is no appreciation on a U.S. dollar basis.
The Canadian tax regime allows a taxpayer to claim a foreign tax credit for the U.S. federal and state income taxes paid on the gain. The end result is usually that the taxpayer will pay overall tax at the higher of the two countries’ rates. Note that to qualify for the credit, the U.S. tax must be the amount calculated under U.S. rules and a return will need to be filed and in many cases provided to the Canadian tax authorities.