The purpose of this publication is to inform Canadian residents with U.S. real estate holdings of their U.S. tax obligations and the penalties that may result from failure to comply.
U.S. tax consequences for Canadian residents
For the purposes of this publication, the term “Canadian resident” means a person who is a Canadian tax resident under the Income Tax Act. However, please note that the concepts mentioned in this publication do not apply to you if, in addition to being a Canadian resident, you are a U.S. citizen or if you hold a green card.
RENTAL INCOME – U.S. TAX OBLIGATIONS
A Canadian resident generating rental income in the U.S. is subject to a 30% withholding tax on gross rental income. This 30% non-resident tax must be remitted to the IRS by the tenant, and cannot be reduced under the Canada-U.S. tax treaty.
However, the U.S. Tax Act allows non-residents to elect to be taxed on their net rental income. This means that the taxpayer can deduct expenses incurred to earn rental income (such as mortgage interest, property taxes and utilities), and then be taxed on the net income at progressive tax rates, rather than at a flat rate of 30% on gross income. In most cases, it will be more advantageous to be taxed at the progressive rate on net rental income than at the flat rate of 30% on gross income.
In order to make the aforementioned election and avoid the 30% withholding tax on gross rent, Form W-8ECI, “Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States”, must be provided to the tenant.
In addition, to take advantage of the election, you must file a U.S. non-resident income tax return (Form 1040-NR, “U.S. Nonresident Alien Income Tax Return”) and indicate your rental income and expenses; please note that rental expenses will be allocated according to your personal use, if any. What’s more, if tax has been withheld, it will be carried forward on the return and may be refunded in full or in part. For the election to be valid, you must attach a schedule to your tax return indicating that you are electing to be taxed at graduated rates on net rental income for each rental property. This election is valid for the entire time you own the property, as long as you file your tax return (1040-NR) by the required annual deadline.
To be able to file Form 1040-NR, you’ll need to obtain a US Individual Taxpayer Identification Number (“ITIN”) by completing Form W-7, “Application for IRS Individual Taxpayer Identification Number” if you don’t already have one, or if you don’t have a US Social Security number.
You may also be required to file a tax return in the state where the rental property is located. For example, you won’t have to declare your rental income in Florida, as there is no personal income tax in Florida, but this won’t be the case for all U.S. states.
Deadlines and penalties
Form 1040-NR must be sent to the IRS each year before June 15 of the following calendar year. If there is no tax to pay, form 1040-NR can be sent no later than 16 months after the due date, so that the election to be taxed on net income is still valid.
If you don’t file your tax return on time, the 30% withholding tax will be applied to your gross rental income, plus interest and penalties. In this way, the IRS encourages Canadian taxpayers to file their tax returns annually.
SALES TAX
Generally speaking, when you own a rental property in the State of Florida (hereinafter “FL”), FL state sales tax must be charged on rental income, with some exceptions.
LF sales tax is applicable at a rate of 6% on all rental charges paid for the right to use, occupy or sleep in transient accommodations. The State of FL defines temporary lodging as any hotel, apartment, condominium, cottage, etc.
However, there is an exception to this rule. If the tenant signs a lease for continuous occupancy in temporary accommodation for more than 6 months, the rental income will be exempt from sales tax for the duration of the lease.
Discretionary sales surcharge
The state of FL has a sales tax known as the “Discretionary Sales Surtax”. The latter is a sales tax for cities and counties. Note that some counties do not have a discretionary sales surcharge.
This sales surtax is imposed on all rental income earned in the LF state, whether or not the landlord is located in the state, at a rate ranging from 0.25% to 1.5% depending on the county.
This sales surcharge is levied on temporary accommodation rental income. It applies to all rental revenues, even those exceeding $5,000.
Please note that the above-mentioned exception for sales tax also applies to the discretionary sales surcharge.
Compliance – Sales tax
Temporary accommodation owners must register each temporary accommodation separately.
Rebates and sales tax returns must be filed with the Florida Department of Revenue.
A penalty of 10% plus interest is imposed on the amount of any late rebates (sales tax and discretionary sales surtax) and a penalty of $50 for late-filed returns.
SALE OF PROPERTY – U.S. TAX OBLIGATIONS
If a Canadian resident disposes of a property located in the United States, a 15% U.S. withholding tax will be withheld and remitted to the IRS under the rules of the Foreign Investment in Real Property Tax Act (“FIRPTA”).
You must obtain an ITIN, by filling out form W-7, if you don’t already have one, or if you don’t have a U.S. social security number. Your ITIN and the tax withheld will be indicated on the IRS remittance form, Form 8288, “U.S. Withholding Tax Return for Dispositions by Foreign Person of U.S. Real Property Interest” and Form 8288-A, “Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests”.
The withholding tax is an instalment of U.S. income tax payable on the gain realized at the time of sale, and will be refunded if it exceeds the tax actually payable.
There are THREE EXCEPTIONS for reducing or eliminating the 15% withholding tax.
- The first exception applies to dispositions where the value of the property is US$1,000,000 or less, then the rate of U.S. withholding tax will be 10% instead of 15%, if the following two conditions are met:
- The property is acquired by the buyer with the intention of using it as his or her principal residence (at least half of the time the property is used for personal purposes at
during each of the two years following the sale); and - The realized selling price for this property does not exceed US$1,000,000.
- The property is acquired by the buyer with the intention of using it as his or her principal residence (at least half of the time the property is used for personal purposes at
- The second exception applies if the property is sold for US$300,000 or less to a buyer who intends to use it as his or her principal residence. At this point, there is no withholding tax on the sale price of the property. However, the capital gain on the sale remains taxable in the U.S. and a U.S. tax return must be filed.
- The third exception applies to a reduction in the withholding tax rate. A Canadian must file an Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests (Form 8288-B) with the IRS. On Form 8288-B, he must demonstrate that the U.S. tax payable on the capital gain will be less than 15% or 10% of the sale price (as the case may be). The IRS will issue a “Withholding Certificate” indicating the amount of tax to be withheld by the purchaser in lieu of the fixed withholding of 15% or 10% of the sale price. The application should be obtained from the IRS ideally no later than the date of transfer of ownership. Failure to file form 8288-B on time will result in withholding tax being applied and the seller may receive an early refund. The IRS will generally issue the certificate within 90 days.
The U.S. Tax Identification Number (ITIN) must be obtained by the seller and buyer prior to or at the time of sale to ensure that any tax withheld is allocated to the correct account. Form 8288-B must be completed and forwarded to the IRS to claim exemption from the 15% or 10% non-resident withholding tax, as applicable.
Capital gain or loss resulting from the sale of U.S. real estate by a non-resident must be reported on a U.S. non-resident income tax return (Form 1040-NR). As a Canadian resident, you must also report the capital gain or loss on your Canadian income tax return. If there is a capital gain on disposition in both countries, the U.S. has the first right of taxation and U.S. income tax can be claimed as a foreign tax credit on your Canadian tax returns (federal and provincial).
As with rental income, a tax return may also be required in the state where the property sold is located, depending on the legislation of that state.
Deadlines and penalties
Form 1040-NR must be filed by June 15 of the following calendar year. If you do not file your return by the due date, you will be subject to a penalty for non-filing. The penalty is based on the unpaid tax at the due date. The penalty is usually 5% of the amount of tax due for each month or fraction of a month for which the return is late, but may not exceed 25% of the amount. If you file your return more than 60 days after the due date, the minimum penalty is the lesser of $135 or 100% of the unpaid tax.
You can contact Éric Panu-Bulé, a member of our international tax team, if you have any questions about this note on U.S. tax obligations.
This Demers Beaulne U.S. Tax Liability Information Bulletin addresses international tax issues affecting Canadians and non-residents. It is of a general nature and aims to deal with cross-border issues in the field of taxation. Please note that this bulletin is not intended to replace professional advice.
The International Tax Services team de Demers Beaulne is able to provide advisory services on international tax issues, from both a Canadian and international perspective, including cross-border acquisitions and restructurings, financing, repatriation and exit strategies, expatriate services, tax compliance services and U.S. and Canadian tax returns.
