There are many answers to the question of whether you need to pay tax on the sale of your U.S. property. Just ask your neighbours sitting around the community pool at your Sunshine State resort. We call them poolside lawyers. Lots of information, but not necessarily correct information.
How to calculate a capital gain
Let’s say Bob and Pat bought a condo in Naples, Florida for $1 million (U.S.) five years ago and took title in a cross border trust. If they receive an offer for $1.4 million (U.S.) today, $400,000 (U.S.) appears to be the gain. That amount is more accurately called the “gross gain.”
Gross gain versus net gain
Let’s try to reduce that gain for tax purposes using the following information: CHART
HOW TO CALCULATE A CAPITAL GAIN
Gross gain versus net gain,
all figures in U.S. dollars
PURCHASE PRICE*
$1,000,000
Closing costs on purchase
$10,000
Renovations
$150,000
Special Assessments
$50,000
Adjusted cost base
$1,210,000
* bought 5 years before sale
$1,400,000
SALE PRICE
-$70,000
Broker commissions
-$9,800
Land transfer tax
-$200
Miscellaneous
-$10,000
Closing costs on sale
$1,310,000
Net sales price
NET GAIN: $1,310,000 - $1,210,000 = $100,000
CARRIE COCKBURN/THE GLOBE AND MAIL,
SOURCE: DAVID ALTRO
HOW TO CALCULATE A CAPITAL GAIN
Gross gain versus net gain, all figures in U.S. dollars
PURCHASE PRICE*
$1,000,000
Closing costs on purchase
$10,000
Renovations
$150,000
Special Assessments
$50,000
Adjusted cost base
$1,210,000
* bought 5 years before sale
$1,400,000
SALE PRICE
-$70,000
Broker commissions
-$9,800
Land transfer tax
-$200
Miscellaneous
-$10,000
Closing costs on sale
$1,310,000
Net sales price
NET GAIN: $1,310,000 - $1,210,000 = $100,000
CARRIE COCKBURN/THE GLOBE AND MAIL, SOURCE: DAVID ALTRO
HOW TO CALCULATE A CAPITAL GAIN
Gross gain versus net gain, all figures in U.S. dollars
PURCHASE PRICE*
$1,000,000
Closing costs on purchase
$10,000
Renovations
$150,000
Special Assessments
$50,000
Adjusted cost base
$1,210,000
* bought 5 years before sale
$1,400,000
SALE PRICE
-$70,000
Broker commissions
-$9,800
Land transfer tax
-$200
Miscellaneous
-$10,000
Closing costs on sale
$1,310,000
Net sales price
NET GAIN: $1,310,000 - $1,210,000 = $100,000
CARRIE COCKBURN/THE GLOBE AND MAIL, SOURCE: DAVID ALTRO
Uncle Sam wants the tax
The IRS will tax the net gain because the property is located in the U.S. The tax rate will depend on how title was held. If Bob and Pat bought personally or in a cross border trust, the IRS rate would be up to 20 per cent the net gain ($20,000 U.S.). If title was held in a Canadian corporation, the IRS rate would be 21 per cent under the new U.S. tax act, while the Florida state tax would be an additional 5.5 per cent. (Note that Florida doesn’t tax individuals or cross border trusts.) By the way, if you buy and sell in less than 12 months, where title is in your name personally or in a trust, the IRS tax rate is 37 per cent!
IRS FIRPTA withholding tax
The general rule in the Foreign Investment in Real Property Tax Act (FIRPTA) is that 15 per cent the gross sale price, $210,000 (U.S.) for Bob and Pat, should be remitted to the IRS at closing. Is that a tax? Actually, it’s the amount to be applied against net capital gain tax. However, it’s rather draconian to force Bob and Pat to send $210,000 (U.S.) to the IRS when the net tax is only $20,000 (U.S.).
A better plan
If Bob and Pat send $210,000 (U.S.) to the IRS, they will need to file a U.S. income tax return (Form 1040NR) in the following year to request a refund of $190,000 (U.S.) ($210,000 - $20,000). But they might have to wait one to two years to receive their refund.
A better plan: have the title company hold the $210,000 (U.S.) in escrow at closing. The cross border tax attorney would send the IRS Form 8288-B (an application to reduce withholding), along with documentation proving the gain is $100,000 (U.S.) and tax owing is $20,000 (U.S.) . Once the IRS issues the withholding certificate reducing the tax owing to $20,000 (U.S.) , the title company can send $190,000 (U.S.) to Bob and Pat and remit the remaining $20,000 (U.S.) to the IRS. Remember to keep invoices for renovations – you’ll need these to help obtain a withholding certificate.
Reporting the gain to CRA
You have to report the sale to CRA on your Canadian tax return. However, you can apply the Canada-U.S. Tax Treaty to deduct the U.S. tax paid against the Canadian tax as a foreign credit.
So if the U.S. tax was $20,000 and the Canadian tax is approximately 25 per cent, which is $25,000 (disregarding currency exchange), then the amount payable to CRA is $5,000 ($25,000 - $20,000).
The dreaded double taxation
Bob and Pat paid a total of $25,000 (U.S.) of tax even though they were obligated to file with the IRS and CRA. The magic is in the foreign credit. However, if they held title to their Naples property in a Limited Liability Company (LLC), an S-Corp, a Limited Liability Partnership (LLP), a Limited Liability Limited Partnership (LLLP), a standard Florida Revocable Trust, or a Florida Land Trust, it is very likely that CRA wouldn’t allow a U.S. foreign credit. The result? The dreaded double taxation.
An exception to the 15% withholding rule
There is an exception to the 15 per cent withholding where gross sales price is under $300,000 (U.S.) and the buyer signs an affidavit that (1) the price is under $300,000 (U.S.), and (2) the buyer intends to use it for personal use at least 50 per cent of the time the property is in use (3) over the next two years.
If the buyer is a corporation, the use won’t qualify as personal. However, if the buyer is a revocable or Cross Border Trust or an individual, the exemption will apply if the above criteria are met, whether the buyer is a U.S. person or a non-resident of the U.S.
In any event, remember, the year after the sale you are obligated to file a U.S. income tax return and also include the gain in your Canadian income tax return.
David Altro is the managing partner of Altro LLP, which specializes in cross-border tax and estate planning, real estate and immigration and has offices in Canada and the United States. Matt Altro is the president and CEO of MCA Cross Border Advisors Inc. and a certified financial planner in Canada and the United States.