What is withholding tax in real estate? Do Canadian pay capital gains tax on U.S. real estate? A Canadian selling U.S. property, need to know the U.S./Canadian tax implications. Knowing all the facts will help you keep more of the profits into your project and minimize tax.
Canadian buying US properties need to understand the tax issues and the potential to minimize our tax payable.
The excellent climate in cities like Florida and Arizona attracts people in Canada to buy a vacation property in the United States. As of the beginning of 2021, the prices of real properties in the USA may be very attractive compared to Canadian real estate, which attracts many Canadians to invest in the US in real estate.
This blog focuses on tax issues that a Canadian buyer may face or awareness of which may help them plan and minimize their taxes. The various states in the United States may have different tax laws and the situation in each state has to be looked into separately.
Let’s look into the following issues:
While looking into the above issues it is assumed that you are a US Citizen or US resident for tax purposes.
US tax on your rental income
When you earned rental income in the US, your rental income is taxable in US. As per the US and Canada tax treaty income derived by a resident of one country from the real property situated in another country may be taxed in another country. The only exception you have is if you rent your vacation property for less than 15 days.
Property held for Investment purposes and connected to a U.S. trade or business
Do you have rental income as discussed above? Now the taxation of rental income earned in both the countries either in the United States or in Canada may be similar, particularly the way it is taxed. There are two methods that you can use to pay your taxes.
Method 1 – Withholding tax method
Under this method, if your property is situated in the United States and you are a resident of Canada, you pay 30% withholding tax on your gross rental income derived from the property situated in the United States and you do not have to file a tax return in the United States. In Canada, if your real property is situated in Canada and you are a resident of the United States, you pay 25% withholding tax on your gross rental income derived from the property situated in Canada and you do not have to file a tax return in Canada.
The tenant reports the withholding tax deducted to IRS/CRA and pays withholdings tax deducted.
Method 2 – File your tax return and pay tax on net rental income
Residents of either country (the US or Canada) having property situated in another country can choose to file a tax return and pay tax on net rental income. You deduct your expenses from your gross rental receipts and calculate tax on net rental income. Under this method, your tax on net rental income will be calculated at a graduated tax rate. On US tax you have to elect that your rental income is effectively connected to a trade or business in the united states. In both countries, you may not be subject to tax under this method however, you may need to pay an estimated tax. The major expenses that you can deduct from your gross rental receipts are mortgage interests, insurance, property tax, management fees, utilities, and other related expenses and depreciation.
In the United States while reporting your net rental income it is mandatory to claim depreciation. In Canada, you can claim depreciation as much as you want however you cannot claim depreciation to show a loss from a rental property.
Having explained the above two methods, now the question is which one is better. Depending on your overall tax situation, your investment objectives, and you may need to consult with your tax expert. In general, you may have more tax liability under the withholding tax method.
Double taxation issues
A resident of either country (the US or Canada) has to report in their tax residency country their worldwide income. Resident US or Canada can claim a foreign tax credit for the foreign taxes paid in the United States or in Canada under the US-Canada tax treaty. Foreign taxes paid include taxes paid under either of the two methods explained above. However, your claim of foreign taxes paid on your rental income will be limited to the taxes payable on rental income in your country of residency. With this limitation, for example when a Canadian choose to pay taxes in the United States as per the withholding tax method then he will pay 30% tax in the US. While doing his Canadian return, he will report net rental income, i.e., gross rent receipts expenses. Most likely and depending on his tax situation, his Canadian taxes payable on the US property rental income will be much lower than 30%. In which case he may not be able to recoup the entire withholding taxes paid by the United States. Better he should report his taxes in the United States on net rental income and file a US tax return under the 2nd method.
US tax on your capital gain when you sell the properties
Generally, you are subject to 15% withholding tax on your gross sales proceeds when you sell your property in the United States.
US tax filing requirement
If you sell your property in the USA you need to file a U.S. non-resident income tax return (Form 1040NR) to report the sale of your U.S. real estate.
The rules of a recapture of depreciation and/or un-recaptured section 1250 gain may apply.
You may be able to set off any losses that have been carried forward.
Under the US tax system, the capital from the property is categorized under long-term capital or short-term capital gain. If you held the property for more than 12 months before selling, you can avail of a preferential tax rate which is up to 20%. If you held the property for less than 12 months, your short-term capital gain will be treated as ordinary income which is subject to tax at your U.S. marginal tax rate.
There are situations where you can avoid the capital gains tax, which is called capital gains tax exemption/tax deferral. To learn more please visit our blog “Capital gain tax exemption.”
RKB Accounting has expertise in cross-border taxation and has been providing accounting and taxation services for the last fifteen years in Canada and USA. RKB services include incorporating a business on both sides of the border, bookkeeping, sales tax, payroll, and corporate and personal income tax. RKB’s expertise includes cross-border tax planning, long-term tax planning, helping business start-ups, business structure planning, and resolving complex tax matters. RKB a CPA(Delaware), CA(India), and CIA(USA) has over 25 years of experience in accounting and taxation in dealing with various countries in the world.
Disclaimer: Information in the blog/post/article has been presented for a broad and simple understanding. This is not legal advice. RKB Accounting & Tax Services does not accept any liability for its application in any real situations. You need to contact your accountant or us for further information.