Canadians who sell real estate located in the United States (“U.S.”) need to be aware of the various tax complexities that result; this article will go through the requirement for withholding tax on the sale as well as the tax return implications in both Canada and the U.S.
The sale is subject to withholding
The Foreign Investment in Real Property Tax Act (FIRPTA) authorizes the U.S. to tax foreign persons on the disposition of U.S. real property interests. Therefore, FIRPTA requires that if you are a Canadian resident selling real estate located in the U.S. you are subject to withholding on the sale. The normal withholding rate is 15% of the total sale price and must be remitted to the IRS at the time of sale. Once a U.S. income tax return is filed to report the U.S. property sale, any capital gains tax is deducted from the FIRPTA withholding, and if the tax is lower than the amount withheld any excess will be refunded.
Exceptions to 15% Withholding
There are a few exceptions to the 15% withholding which are as follows:
- If the sale price is less than $300,000 and the buyer intends to use at least 50% of the home as a principal residence the withholding can be reduced to zero;
- If the sale price is greater than $300,000 but less than $1,000,000 and the buyer intends to use at least 50% of the home as a principal residence the, then the withholding is reduced to 10%; or
- You can request a withholding certificate from the IRS on the basis that the expected U.S. tax liability will be less than 10% or 15%.
A withholding certificate takes time and therefore it is important to plan for this far in advance of the closing date. The withholding certificate would only be filed if your expected U.S. tax liability is significantly less than 15% of the selling price. The withholding certificate is obtained by filing Form 8288-B and ideally would be completed and filed with the IRS before the sale closes. If you suspect this is the case you will want to notify your accountant as soon as possible and ensure you or your escrow agent handling the sale has the following information readily available:
- Individual tax ID number;
- Sale Price of the property (purchase agreement);
- Purchase Price and preferably the original purchase document;
- Cost of any improvements to the property listed by year (please ensure receipts are retained as these may be needed in case of an audit);
- Depreciation schedule if the property was previously rented;
- Copy of your most recent U.S. tax return; and
- Anticipated total income from other sources if differs from your prior year tax return provided.
The capital gain will be reported on your U.S. and Canadian tax return
If you sell your home for more than what you paid for the property (plus any improvements) the difference is a capital gain and is subject to tax in both countries.
Since the property is real property physically located in the U.S., they have first right to tax the capital gain regardless of your residency. The property may be taxed federally and in the state the property is located, if that state levies income tax on individuals.
If you are not a U.S. citizen a U.S. Non-Resident Income Tax Return (1040NR) must be filed. This return is due by June 15th of the following year of the sale.
Additionally, as a Canadian resident, you are taxed on your worldwide income, therefore the capital gain will also be reported on your Canadian income tax return.
You may be thinking this is unfair being taxed in two countries, but you are in luck! Canada will allow you to claim your taxes paid on your U.S. income tax return as a foreign tax credit to offset the tax owing on your Canadian income tax return. This helps to ensure that you are not subject to double taxation.
Capital Gain Calculation and Tax Rates
The capital gain is calculated as follows:
Sale Price – Selling costs – (Purchase price + purchase costs + any significant renovations/ improvements) = capital gain/loss.
In Canada, 50% of the value of the capital gain is taxable. The portion of taxable capital gain is then taxed at your marginal tax rates which are based on your level of income and can range from 10.03% to 24.90% of the entire capital gain or 20.06% to 49.80% of the taxable portion of capital gains.
In the U.S., there are short-term capital gains and long-term capital gains which get taxed at different rates. Long-term capital gains are if the property was held for more than one year and are taxed at either 0%, 15% or 20% depending on your income level. However, if the capital gain is classified as short term it is taxed at ordinary income rates depending on your income level.
U.S. Long-term capital gains tax rates for the 2021 tax year are as follows:
|FILING STATUS||0% RATE||15% RATE||20% RATE|
|Single||Up to $40,400||$40,401 – $445,850||Over $445,850|
|Married filing jointly||Up to $80,800||$80,801 – $501,600||Over $501,600|
|Married filing separately||Up to $40,400||$40,401 – $250,800||Over $250,800|
|Head of household||Up to $54,100||$54,101 – $473,750||Over $473,750|
If you have recently sold, or are planning to sell, a U.S. property and would like help to navigate you through the process please feel free to reach out to one of our cross-border specialists.