Canadians Owning US Real Estate

A growing number of Canadians own rental property or personal real estate in the United States. Such owners should ensure they are aware of the applicable US income tax requirements. Taking steps to understand and comply with these US tax rules could result in significant US income tax savings and avoidance of penalties and interest. 

Canadians collecting rent from US real estate

When a Canadian individual receives passive rental income from real estate in the United States, 30% of the gross rental payment must be withheld and remitted to the Internal Revenue Service (IRS) on behalf of the Canadian property owner. The Canadian owner must file forms with the IRS by March 15th of the following calendar year, reporting the gross income and the taxes withheld. Failure to file such forms and remit the withholding taxes will result in penalties. 

Individuals may, however, choose to elect to have their passive rental income taxed as if it was "effectively connected with the U.S. trade and business" by filing a US income tax return and paying US tax on the net rental income. An election to do so must be filed with the return for the year in which the property is first rented. Once such an election is made, there is no obligation to withhold the 30% tax. The election will remain in effect until the IRS consents to a revocation. 

Generally, Canadian residents have until June 15th of the following year to file US income tax returns without penalties. Late filing of returns is usually allowed, though often subject to penalties. However, if the US tax return is not filed by October 15th of the second year following the year the rent was collected, the IRS may deny the deduction of expenses against the rental income, causing the gross rent to be subject to the 30% flat tax. For example, if a Canadian collected US rental income in 2005, the US tax return must be filed by October 15, 2007. If it is not, the gross rent could be subject to a 30% tax. If returns for years prior to 2005 have not been filed, the individual must decide if it is best to file voluntarily now and hope the IRS will allow tax to be paid on the net rental income, or live with the risk of the IRS assessing the 30% tax at a later date. The IRS is likely to become aware of the issue when the property is sold. It is often best to file late income tax returns voluntarily and pay the tax due. Professional advice should be sought in such a case, however.

Canadians selling US real estate

Gains from dispositions of US real estate are subject to tax in the US regardless of whether the property has been used personally or rented. If a Canadian disposes of US real estate, the purchaser generally is required to withhold and remit 10% of the purchase price, with certain limited exceptions. This withholding essentially represents a prepayment of the capital gains tax that the Canadian may owe in the US. The Canadian must file a US tax return reporting the capital gain, and the withholding tax is credited against the actual US tax liability, if any. If the withholding tax exceeds what is due, the IRS will issue a refund to the Canadian once a US tax return is filed. This process can, of course, take a significant amount of time and in the meantime the 10% tax remains with the IRS. Depreciable property may also give rise to recaptured depreciation, and the cost base for capital gains purposes may be reduced by prior depreciation amounts, even if these amounts were not claimed as deductions in prior years.

The withholding tax can be reduced if a withholding certificate is issued by the IRS. A withholding certificate may be issued if the amount that would be withheld is more than the maximum tax liability on the sale. Normally, the IRS requires 90 days to act on an application for reduced withholding. The Canadian seller, the purchaser, or the agent of either may request this withholding certificate, provided all parties to the transaction have an Individual Taxpayer Identification Number. Canadians are advised to apply for an Individual Taxpayer Identification Number well in advance of any potential real estate sale to ensure that the IRS can consider any such application for reduced withholding prior to the sale closing.

In addition to the income tax requirements mentioned above, there may be other issues to consider, such as US estate taxes or sales taxes. Of course, Canadian residents must also report all rental income and capital gains on their Canadian tax returns regardless of any US returns filed.

Contact your Collins Barrow advisor for professional assistance regarding ownership of US real estate.

Karen Sands is a tax partner in Collins Barrow's Kingston member firm.