Recent trends of a strong Canadian dollar and relatively low
U.S. real estate prices have resulted in more Canadian residents
investing in U.S. properties.
If these investments are made in a pooled structure for tax and
legal purposes, such as a U.S. partnership, the Canadian investor
will receive (typically in April) U.S. Schedule K-1 reporting his /
her share of partnership income / loss, as well as Form 8805,
reporting any tax withheld and remitted to the IRS (and any related
State tax filings) for the prior year. It is important to note that
the income / loss reported on the Schedule K-1 is prepared in
accordance with U.S. income tax rules.
A Canadian investor is also required to report the income / loss
on his or her Canadian tax return. However, there are key timing
differences between U.S. and Canadian income tax rules that impact
the calculation of taxable income / loss for a Canadian investor in
foreign property. The following are some common income adjustments
that may be required when comparing reporting requirements between
the two tax regimes:
Cash basis accounting: Cash basis accounting may be permitted
under U.S. tax rules; however, accrual accounting is required for
Canadian tax purposes.
Depreciation: Under U.S. tax rules, a partnership must deduct
allowable depreciation, which can result in a loss being reported.
In contrast, Canadian tax rules often limit depreciation to an
amount that will reduce taxable income to nil.
Repairs and maintenance: Canada generally allows these
expenditures to be deducted annually, however, U.S. tax rules may
require some of the expenses to be capitalized and depreciated over
a specified period of time.
Prepaid rents: Under U.S. tax rules, prepaid rents are included
in income upon receipt whereas for Canadian tax purposes, they are
reported in income when earned.
Debt repayments: Solely for Canadian tax purposes, the investor
may be required to report additional income or gains from foreign
currency transactions on debt repayments that the partnership makes
during the year.
Syndication costs: For U.S. tax purposes, these costs are not
deductible, however, under Canadian rules they are deductible over
a five-year period.
Financing costs: These are deductible over the term of the loan
in the U.S., but deductible in Canada over a five-year period.
As a result of these timing differences, a Canadian investor
that simply converts U.S. income / loss (i.e. from a U.S. Schedule
K-1) to the Canadian equivalent will likely be reporting incorrect
taxable income / loss in their Canadian tax return. Unless the U.S.
partnership provides appropriate Canadian tax schedules, an
investor, without access to detailed records of the partnership,
will be hard-pressed to determine their Canadian taxable income or
loss for the year.
Although beyond the scope of this article, investors should also
note they are required to separately track their Canadian at-risk
amount and adjusted cost base of the partnership for tax purposes
which may impact their ability to deduct losses in a particular
An alternative tax and legal structure used by Canadians
investing in U.S. property is a Limited Liability Company (LLC).
The use of LLCs is widespread in the U.S. because they allow
investors a level of legal protection that is normally available
for a corporation, however for tax purposes, the LLC is considered
to be a partnership. Unfortunately for Canadian purposes, an LLC is
treated as a corporation, which means a Canadian investor will
report a foreign source dividend equal to the cash distributions
received (including any tax withheld) as foreign investment income.
However for U.S. tax purposes, they are required to report any
income / loss from the U.S. 'partnership' and taxable at
the applicable marginal tax rate. This may result in double
taxation for the Canadian investor due to the mismatch of foreign
income and tax credits in Canada during the years of ownership and
cause additional double taxation when the underlying real estate
assets are sold by the partnership for a gain.
Depending on the percentage of ownership of the U.S. entity and
cash invested, a Canadian investor may face additional tax
reporting of the U.S. investment on Form T1135, Foreign Income
Verification Statement, Form T1134, Report on Foreign Affiliates
and possibly Form T106, Report of Transactions with Foreign Related
Parties. Failure to file these forms on a timely basis carry hefty
penalties and care must be taken to address the filing thresholds
and applicable due dates.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Russell v. Township of Georgian Bay provides a useful reminder of the fact that while municipal officials sometimes appear to hold all of the cards in disputes with home owners, that is not always the case.
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