U.S. Real Estate Issues

The U.S. real estate recovery is underway and approximately 40% of recent existing home sales have occurred in the southern United States.[1]  Many Canadians have played a role in this recovery by purchasing U.S. property, either for personal use, rental use, or both. For these Canadians, there are several U.S. tax matters to consider, including obtaining an Individual Taxpayer Identification Number (ITIN), properly filing required U.S. tax returns, and applying for a withholding certificate. Properly addressing these matters is a requirement under U.S. income tax law, and can minimize tax withholdings and liabilities during ownership and at the time of sale.

When you purchase property in the U.S., it is good practice to obtain an ITIN right away. The ITIN is similar to a Canadian Social Insurance Number, and is used in all your U.S. tax filings. The process for obtaining this number changed recently. You can read more about obtaining a U.S. ITIN on the Internal Revenue Service (IRS) website. However, it is important to note that there are several requirements that must be met before the IRS will grant an ITIN.

U.S. rental property income is subject to tax in the United States, regardless of the citizenship or residency of the owner. Canadians generally can take a foreign tax credit in Canada for any taxes paid in the U.S. However, in many cases Canadians with U.S. rental properties end up with little or no net profit from the rental operation, and consequently no U.S. federal taxes owing. Some states, such as Florida, Nevada and Texas, do not impose a state income tax. If your rental property is located in a state that does impose personal income tax, you may also need to file a state tax return each year. Some cities also impose an income tax. It is important to be aware of, and compliant with, all federal, state and local income tax laws.

Many Canadians use  property management companies to handle bookings, to collect rents, and to ensure their properties are cleaned and maintained. Your property management company should provide you with a U.S. tax slip to be used in filing your U.S. taxes (Form 1042-S). If you handle the property management yourself, you should keep detailed records about renter names and the dates the property is rented, and if possible, have rental contracts in place. You should also keep receipts for any expenses related to the property. Most of these expenses should be deductible against rental revenue.

There are only a few differences between what can be claimed as a rental expense in Canada and in the U.S. As an example, for Canadian tax purposes, repairs and maintenance are tracked together; in the U.S., they are reported separately. Some of the most common deductible rental expenses include advertising, agent fees, insurance, interest, property taxes and condo fees.

When you are ready to sell your property, you will be subject to the Foreign Interests in Real Property Tax Act (FIRPTA), a U.S. federal law that requires the purchaser of U.S. property being sold by a non-U.S. person to withhold 10% of the gross amount realized in the sale. This withholding tax is often viewed as a “temporary” tax, and is remitted to the IRS at the time of the transaction and held as a tax installment on the taxpayer’s account.

There are some exceptions to the withholding requirement that may allow the buyer to reduce or eliminate the amount of tax withheld. To reduce the withholding, buyers must apply for a withholding certificate from the IRS. The IRS generally acts within 90 days of receiving a complete withholding certificate application, but the short escrow period in a typical U.S. rental property sale would likely not allow for obtaining an ITIN and withholding certificate. The decision to obtain a withholding certificate depends on a number of factors, including the amount of withholding tax that would apply absent the certificate, as well as the timing of the sale (it may be easier simply to allow the maximum amount of FIRPTA tax to be withheld and file a tax return as soon as possible to recover the excess withholding amount).

If the sale of the property results in a capital gain, it will be subject to capital gains tax, which works differently in the U.S. than in Canada. While only 50% of capital gains are taxable in Canada, 100% of U.S. capital gains are taxable, but generally at a rate below the standard U.S. tax rate. Filing a U.S. tax return to report the capital gain allows you to calculate the actual tax on the capital gain, and usually have some of the FIRPTA withholding refunded, assuming the tax as calculated on the tax return is lower than the FIRPTA withholding.

The issues above are just a sample of some of the common issues Canadians face when owning U.S. real property. Be sure to consult a tax practitioner with experience in U.S. rental property and sales to ensure that your selling experience is as smooth as possible. If you have not yet purchased a property but are considering it, speak to your Collins Barrow advisor prior to the purchase, as there are different ownership structures that could minimize your exposure to U.S. estate tax and other taxes.

Barbara S. Wing, CPA, CA, CFE, CPA (North Carolina), is a Manager in the Chatham office of Collins Barrow.