Canadians who purchased US vacation property in the past few years may find that now is the ideal time to sell, considering the interplay between rising US real estate prices and the recent devaluation of the Canadian dollar (CDN) relative to the US dollar (USD). It is also possible that Canadian capital gains inclusion and/or tax rates could rise over the next few years, therefore a gain today could be taxed at a lower rate than it would be one, two or three years from now. Before you sell your US vacation property however, consider the following factors:
DECLINE OF THE CANADIAN DOLLAR
If you didn’t borrow significantly to purchase your property, the appreciation of the greenback against the loonie, combined with the appreciation in US real estate, means you will have an even larger gain when the USD sale proceeds are converted into CDN funds.
If you borrowed US dollars to purchase the property, the decline of the CDN dollar will hurt. Although the CDN gain may be significant, the ultimate cash realized on a sale may be less than expected if any USD debt incurred to acquire the property is repaid.
PAYING TAX ON GAINS AND THE FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT
The gain on sale of US real property is US sourced income, therefore the US has the right to tax the gain before Canada does, with the resulting gain and corresponding tax liability being determined in accordance with US income tax legislation. The Foreign Investment in Real Property Tax Act (FIRPTA) may also apply, requiring the purchaser to withhold and remit 10% of the selling proceeds to the IRS for transactions under $1M USD and 15% for transactions over $1M USD.
As a Canadian resident, you are liable for tax on your worldwide income, which includes any gain on the sale of US real property. Accordingly, the CDN equivalent gain will be taxable in Canada (likely as a capital gain) and Canadian federal and provincial income taxes will apply (the Canadian Tax Otherwise Payable). However, in an attempt to avoid double-taxation, Canada has a foreign tax credit (FTC) regime to allow a FTC (or deduction) to be claimed against the Canadian Tax Otherwise Payable.
The sale of US real estate owned by a cross-border trust may result in a gain being realized by the trust for both US and Canadian income tax purposes. The Canadian “attribution rules” may also apply in respect of the gain, so caution must be exercised before any income tax returns are filed.
The rules that apply to Canadian resident individuals, partnerships, or trusts are similar to a Canadian corporation in respect of the calculation of the gains (US and Canada) and the application of FIRPTA. However, the resulting overall tax burden (US and Canada) including potential taxable benefits, significantly impact the after-tax cash flows from the sale of real estate owned by a Canadian corporation.
Moodys Gartner Tax Law is here to help you weigh your options. Contact us to find out more.