Canadians selling U.S. real estate face a number of challenges, most notably the difficulty in finding someone with special training on this topic. Given the high U.S. dollar, many Canadians are now looking to dispose of their U.S. property, but not many advisors have carefully researched this topic and developed the expertise necessary to help with these sales. As a result, the escrow agent, the real estate agent and the accountant you deal with may offer conflicting advice. In order to make sense of their perspectives and cope with the limited expertise available, be sure to keep the following issues in mind when selling U.S. real estate.
When a Canadian sells U.S. property, that sale is subject to the Foreign Investment in Real Property Tax Act (FIRPTA) income tax withholding. There are two factors used to determine the percentage of tax withholding: the sale price and the intended use of the property. The withholding tax rate can be either 0%, 10% or 15%, depending on the combination of the two factors. Unfortunately, the instructions on the IRS website are long, confusing and sometimes contradictory. Unless you read the entire act very carefully, it's hard to know how this works. In order to complete this process correctly, you will need to go through the steps in the correct sequence, but not every advisor is well-versed in the full process. To overcome this confusion, it is essential that you get the perspective of an expert advisor who is familiar with FIRPTA.
Recent rule changes
In the past, a 10% tax would be imposed if: (a) the property sold for more than $300,000 or (b) the purchaser used it as a rental property. However, these rules were recently revised. In cases where the sale price is more than $1 million or the buyer uses it as a rental property, the withholding rate increases to 15%. If the sale price is between $300,000 and $1 million and the buyer plans to use it personally, the tax withheld is still only 10%. If the sale price is less than $300,000 and the buyer plans to use it personally, no tax will be withheld. Some states have enacted similar FIRPTA type laws, so there may be a state tax withholding component as well.
Reducing the amount of tax withheld
One effective strategy for reducing the amount of tax withheld is to specify in your listing that the person buying your property must use it primarily as a personal residence. In most cases, that will significantly decrease the tax withholding. It is also important to be aware of the different tax levels. If the sale price is $305,000, there will be 10% tax withheld. However, if the sale price is $299,000, there is not going to be any tax withheld. In other words, dropping the sale price by a few thousand dollars can actually increase the amount of money in your pocket. It may also be possible to reduce the amount of tax withholding by applying for a withholding certificate (Form 8288-B) prior to the closing date of the sale.
There are several common misunderstandings among Canadians selling U.S. property. For one, many overlook the fact that they still each have to file a U.S. tax return and, in many cases, a state tax return, whether there is tax withheld or not. It's also important to note that each owner has to file a separate tax withholding slip (Form 8288-A). For example, if the owners are a husband and wife, each person's form would include 50% of the sale price and 50% of the tax withheld. Your escrow agent may also require you to have – or apply for – an Individual Taxpayer Identification Number (ITIN) before the sale closes, even though you may not be eligible for one yet.
Getting an ITIN number
If you are required by law to file a U.S. Individual Income Tax Return, but are not eligible to obtain a U.S. Social Security Number, you will need an Individual Taxpayer Identification Number. The IRS will only issue you an ITIN number if you follow the correct procedure and meet the necessary requirements. For example, you can apply for an ITIN number when you have final sale documents, but pending sale documents don't count. The other option is to apply with your actual tax return. If your application doesn't meet one of these requirements, the IRS may reject your application or request more information, which could cause delays in processing your tax return and receiving your refund.
The impact on your Canadian tax return
The sale of your property has to be reported on both your American tax return and your Canadian tax return. It is common for there to be little or no tax owing to the U.S., but for those who purchased their property when the exchange rate was close to par (if not better for Canadians), there may be significant Canadian tax owing. Any tax paid on the U.S. return can be taken as a foreign tax credit on the Canadian return, but due to exchange rate gains, the U.S. tax is often not enough to fully offset the Canadian tax due. In fact, many clients wind up paying significant Canadian tax on their American property sale. However, if you work with your accountant in advance, you can keep your tax bill low and avoid unnecessary payments.
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.