In Part 1 of this series, we discussed the rules of renting out U.S. property as a Canadian – the blog covered withholding rules, reporting obligations and the most tax efficient strategies when it comes to reporting rental income.

Some snowbirds and cross-border investors may eventually find themselves wanting to sell their U.S. real estate to simplify their lives and financial affairs -  perhaps looking to travel less or wanting to reduce the ongoing cost and paperwork of tracking foreign assets. Whatever the reason, selling U.S. property can trigger a unique set of U.S. and Canadian tax rules. It is important to understand these rules before selling a U.S. property.

In Part 2 of this series, we will summarize the key points for anyone preparing to sell U.S. property.

The U.S. Withholding Tax

At the closing of the property, the buyer must withhold 15% of the gross sale price. This is the withholding tax on the sale of property and treated as a prepayment of the potential tax liability. There are certain exceptions to this rule:

Exception 1: No withholding tax if the property sells for US$300,000 or less and the buyer intends to use it as their primary residence.

Exception 2: 10% withholding tax if the sale price is between US$300,000 and US$1 million and the buyer intends to use it as their primary residence.

Exception 3: If tax liability is expected to be less than the amount of withholding tax, you can apply to the IRS using Form 8288-B on or before the closing date of sale to reduce or eliminate the withholding tax altogether.

Filing Requirements in the U.S.

Even as a Canadian, there is an obligation to file a U.S. non-resident tax return (Form 1040NR) to report the sale of the property. The calculation includes the net taxable capital gain, depreciation recapture and an un-recaptured Section 1250 gain (if the property was rented). Please note that even though you may never claim depreciation on the U.S. property while renting it out, the IRS assumes you did and will tax you on the recapture anyway.

It is also important to note that the capital gain inclusion is different than Canada. Whereas in Canada, only half of the gain is taxable, in the US the full gain is taxable at varying rates depending on one’s holding period:

- Long Term Gains (property held over 1 year): Taxed at preferential rate to the maximum federal rate of 20%

- Short Term Gains (property held less than 1 year): Taxed at U.S. graduated tax rates to the maximum federal rate of 37%

The 15% withholding tax is applied as a credit against the final U.S. tax owing based on the U.S. non-resident tax return. If the withholding was more than the true tax liability, you can claim a refund. If not, you will have a balance owing to the IRS.

Filing Requirements in the Canada

Canadians need to report their worldwide income so the same sale must also appear on the Canadian tax return. The sale and purchase cost must be converted into Canadian dollars, using exchange rates at the dates of purchase and any capital improvements made and sold. Currency fluctuations can highly influence the amount capital gains on the property.

It is important to remember that only 50% of the capital gain is taxable and claiming depreciation on the property is optional so you do not need to realize any recapture on the sale of the property if you have not claimed any depreciation.

You may also claim a foreign tax credit for U.S. taxes paid, but the credit is capped at your Canadian tax owing on that income.

Principal Residence Rules

For U.S. tax purposes, Canadians generally cannot use the U.S. principal residence exemption (US$250,000 of capital gain per person exempt from taxes) on the sale of U.S. property because their principal home is usually in Canada.

For Canadian tax purposes, you may designate your U.S. property as your principal residence which can exempt the entire capital gain. To qualify as a principal residence, you must own and live in the property, but it does not have to be your main home. Therefore, you can have multiple properties that would be eligible as a principal residence. Keep in mind that you can only designate one property as a principal residence for any particular year.

In most cases, Canadians prefer to designate their Canadian home for their principal home exemption and rely on the foreign tax credit to offset U.S. tax on the sale of U.S. property.

Joint Ownership Issue

It is common that U.S. property is jointly held (between spouses or family members) even if paid by one person. This makes a lot of sense from an estate planning perspective to ensure a smooth transfer of ownership. But when it comes to selling property, joint ownership can create some tax complexities.

In Canada, the individual that contributes the funds, regardless of who is on the title, is taxed on the rental income earned and capital gains from selling the property due to attribution rules. In the U.S., the reporting of rental income and capital gains may be different for joint ownership. If the tax reporting is different, there is potential for double taxation as an individual cannot claim foreign tax credits incurred by another person. For example, if your spouse pays U.S. tax on their share of 50% ownership, but Canada ignores their share and attribute all the taxes back to you, you may not get any tax credit for the 50% shares paid in U.S. taxes by your spouse.

Therefore, it is important to ensure that the ownership structure aligns with financial contributions or ensure the tax reporting in Canada and U.S. align in that respect to eliminate the potential of double taxation.

Selling U.S. property comes with its own unique circumstances. With proper planning and help of professionals, you can reduce any surprises by limiting withholding taxes and reducing the chance of double taxation which truly help simplify the selling process.

We recommend clients seek legal and tax advice from a professional accountant and lawyer to review the financial obligations related to buying a selling US property.