Are you aware of the tax consequences of selling your U.S. real estate properties? It is important to be aware of potential U.S. and Canadian tax issues to avoid disastrous consequences.
One very important thing many people neglect is to retain complete records of the property purchase and receipts for capital improvements. These are neccesary so that an accurate cost basis can be determined at the time of sale.
Ok, you have put your property on the market, and you have a contract of sale, also known as a purchase sale agreement. Now what? Before you go into that office to sign all the paperwork that will transfer the property to the buyer here are a few things you will want to know:
- 15% Federal withholding tax: As a Canadian or a non-resident of the US you will be subject to a non-resident withholding tax of 15% of the gross sale price, normally payable under the “Foreign Investment in Real Property Tax Act of 1980” (FIRPTA). There are exceptions to this rule…
- The withholding requirement is reduced to 10% when the amount realized does not exceed $1,000,000 and the property is for use by the buyer as a residence. (IRC §1445(c)(4))
- The withholding requirement is eliminated if the purchase price of the property is under $300,000 and the purchaser intends to use the property as a personal residence. (IRC §1445(b)(5))
Is there any other way for the withholding tax to be eliminated or reduced? There is, but you would need to apply for a withholding certificate before the transfer of the property. This would require that you file a Form 8288-B to apply for a withholding certificate to reduce or eliminate withholding. However this should only be done if the seller is exempt from tax, or can show that their maximum tax liability is going to be less than the tax otherwise required to be withheld. Keep an eye out for our future blog “Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interest – What Non-U.S. Citizens need to Know!” for further information.
If any amount of withhelding tax is required, it must be forwarded to the IRS along with Forms 8288 (U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests), and 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests), by the 20th day following the date of sale or if a form 8288-B certificate was requested, the 20th day from the date of the withholding certificate is received.
The IRS will stamp a copy of Form 8288-A to acknowledge receipt of the withheld funds and will send the stamped copy to the seller. Note that, if there is more than one foreign seller, the purchaser is required to prepare separate forms 8288-A for each seller, allocating the amounts based on the full amount being submitted. We have found that many escrow agents erroneously report the sale for multiple sellers on one 8288-A, which can cause major issues and delays when it comes time for each seller to claim their portion of the withholding.
There may also be State tax withholding on the sale as well. Rules for each State are different and not discussed here but is something to be kept in mind.
Many people ask, “Do you still need to file a U.S. tax return when tax has been is withheld?” The answer is yes, you are still required to file a Form 1040NR Nonresident U.S. tax return to report the sale, and that return is due by June 15th in the year following the year of sale. Many people incorrectly believe that their U.S. tax obligations are satisfied through the withholding and fail to file the required U.S. tax returns. The return reports the capital gain or loss on the sale of the property and claims a tax payment for any tax that was withheld. If the tax liability on the return is less than the amount of tax withheld, the excess will be refunded.
Note that before a return can be filed or any refunds received you will need a US Tax ID Number or ITIN. What is that you ask? Well please read on….
The IRS identifies every taxpayer by a number. If you are a US citizen or are an individual eligible to work in the U.S., you are given a “Social Security Number”. If you are an individual that is not a US citizen or are not eligible to work in the U.S., you would need to apply for a US “Individual Tax Identification Number” (ITIN). For more detail on this, see our blog “How to obtain an Individual Tax Identification Number”.
Finally, let us not forget the Canadian side of things. As a Canadian resident, you must report and pay tax on your worldwide income. This includes capital gains realized on the sale of U.S. real estate. Both the proceeds and the cost amounts will need to be converted into Canadian dollars at the exchange rate applicable on the transaction dates so the actual capital gain or loss reported would include a foreign exchange component in addition to any change in the U.S dollar value of the property.
To prevent double taxation, you will claim a foreign tax credit for the U.S. income tax paid on the sale on your Canadian income tax return. The end result is that the Taxpayer’s ultimate tax rate on the sale will be the higher of the effective tax rate between the two countries.