Every winter, countless Canadians head south to enjoy the sunshine in states like Florida, Arizona, and California. Some choose short-term rentals, while others opt to take the plunge and purchase their own U.S. real estate property. Owning real estate in the US has its benefits and can be very appealing, but it comes with its own set of challenges, especially when it comes to taxes and estate planning. Before collecting rent or planning a sale, it is essential to understand the cross-border tax and legal implications.

This three-part blog series breaks down what every Canadian (not a U.S. citizen or green card holder) needs to know when it comes to 1) renting, 2) selling, or 3) estate planning with U.S. real estate. In part 1 of this series, the blog will focus on the rental side of U.S. real estate ownership. This installment will provide a guide to the U.S. and Canadian tax obligations and practical tips/strategies for renting out U.S. property as a Canadian. The focus is on U.S. federal tax rules and does not factor U.S. state taxes. Always check with the appropriate professionals for the tax law specific to the state where your property is located.

Taxation for renting out your U.S. property

If you earn rental income from U.S. property as a Canadian (and you are not a U.S. citizen or resident), both the IRS and CRA want their share of taxes, and choosing how to report the rental income can significantly impact your tax bill.

There are two options for reporting taxes – the only exception to this rule is when rent is earned from a U.S. vacation property that is rented for less than 15 days.

Option 1: 30% Withholding on Gross Rent – A flat amount of 30% of gross rental income is withheld and paid to the CRA. Using this option, you avoid filing a U.S. tax return, but you cannot deduct any expenses (i.e., mortgage interest, property tax, etc.). This option is simple, as the tenant or property manager only needs to file Form 1042 and 1042-S, summarizing the rent and tax withheld. As a result, you are avoiding accounting costs associated with preparing a U.S. income tax return.

Canadian Tax Implications: Even though you may not need to file a U.S. return, you will still need to report the net rental income in Canadian dollars on your Canadian tax return. You can claim a foreign tax credit on your Canadian return for the U.S. taxes withheld, limited to the amount of Canadian tax payable on the same foreign income; any excess U.S. tax paid is not refundable.

Option 2: File a U.S. Tax Return and Pay on Net Income – With this option, you will need to give your tenant or property manager Form W-8ECI, so they do not withhold the 30% withholding tax. By making this election, you take the full responsibility for calculating and paying your actual tax obligations when you file your U.S. Tax Return through Form 1040NR.

This option treats your rental activity as if it is connected to a U.S. trade or business, allowing for deductions such as property taxes, mortgage interest, insurance, management fees, and utilities (similar to Canadian tax rules). The net rental income is taxed at a graduated U.S. tax rate.

Canadian Tax Implications: Similar to option 1, you will need to file a Canadian tax return. Option 2 usually results in lower total tax since it is taxed on net profits. This results in a more effective use of the foreign tax credits.

Summary:

When considering buying US property you should always consult an accountant for advice specific to your situation.

While the paperwork is more cumbersome to file a U.S. tax return, it is usually the more tax-efficient strategy since you are only paying taxes on your net income, so you often pay less total tax and avoid giving up any part of your foreign tax credit. This option can be more appropriate for:

- U.S. property with associated mortgage costs and property taxes that can be deducted

- Long-term rental units with frequent and ongoing expenses

- Investors who regularly keep consistent tax filings with Canadian counterparts that can make use of the foreign tax credit

Even though there is no withholding tax with this option, you may be required to make estimated tax payments. The U.S. also makes depreciation mandatory (even if you decide not to claim it). This depreciation is “recaptured” in the year of sale, which means adding the depreciation amount to your taxable income. This can lead increased taxes.

For some Canadians the added reporting complexity can deter investors from purchasing  US real estate. Reviewing your options with a cross border accountant is recommended to ensure appropriate reporting is fufilled.