This article originally appeared in the January 2013 Tax Stringer, copyright 2013 and is reprinted with permission from the New York State Society of Certified Public Accountants. The link to the Tax Stringer home page is http://www.nysscpa.org/taxstringer/main.htm
The Rental and Sale of Canadian Real Estate
By Larry Stolberg, CA,CPA,CFP
The U.S. economic landscape has made it very attractive for Canadians to purchase vacation or rental properties located in areas of warmer climate. As a result, much has been written with respect to the FIRPTA rules, including IRS Code sections 871, 881, 1441, 1442, 1445 and 1446. But the reverse is also true: Sometimes U.S. persons buy Canadian real estate, and Canada, like the United States, has specific tax rules on this. Often the investor isn’t given the detailed compliance information as part of the marketing process, leading to unnecessary grief for the unwary.
Renting Canadian Real Estate
U.S. citizens who intend to rent property situated in Canada are subject to a non-resident withholding tax of 25 percent on the gross rental pursuant to Section 212 of Part XIII of the Income Tax Act (ITA). The payer or agent who collects the rent is responsible to remit the tax to the Canada Revenue Agency (CRA) by the 15th of the following month in which the rent is paid or credited. Those who manage the property themselves generally take care of remitting and filing obligations. Compound daily interest and a discretionary penalty may be levied for late remittances.
A non-resident account is set-up with the CRA International Tax Services Office at the time of the first rental. A NR4 Information return, which includes a NR4 Summary and NR4 slips reporting the gross rental and tax withheld, is due for filing by March 31 of the following year for individuals and corporations. Estates and trusts have to file their NR4 within 90 days after their year-end. Late filing penalties from $100 to $7,500 are levied for late-filed NR4s. (Note: All dollar figures are Canadian dollars.)
The NR4 slip must indicate an identification number for the investor. It may be a U.S. identification number; however when filing tax returns, non-Canadian individual investors should file CRA Form T1261 for an individual tax number (ITN). The T1261 form requires original or notarized documents of a valid passport, driver’s license or birth certificate.
Corporate investors apply for a business information number (BIN) by filing CRA Form RC1 with a copy of the certification of incorporation. Estates and trusts are provided a number after their first tax return filing.
Exceptions from withholding tax on rental income
Subsection 215(4) of the ITA refers to Regulation 805 of the ITA that states that every non-resident person who carries on business in Canada is taxable under Part XIII on all amounts otherwise taxable under that Part except for those amounts that may be reasonably attributed to the business carried on by the person through a permanent establishment in Canada.
Where the real estate investment is a hotel, or a property where the services provided to tenants are far in excess that would normally be the case with an apartment complex or motel, a case could be made for business income with the gross rental not subject to 25% percent withholding tax.
Business income earned in Canada by a non-resident is taxed under Section 115 of Part I of the ITA. Provincial tax for the province, where the property is located, is applied to taxable income. Returns for individual non-residents reporting business income are due on or before June 15 of the following year. For corporations and trusts/estates, returns are due within six months and 90 days respectively after their year-end. After the first taxation year, tax installments may be required.
Reduction in withholding tax
Where the rental income is considered income from property as opposed to business income, subsection 216(4) of the ITA provides for a reduction in withholding on the gross rental by providing annually to CRA, Form NR6 (“Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent From Real Property or Receiving a Timber Royalty”) for all rental properties. For individuals, the due date is January 1. For corporations, estates, and trusts with a fiscal year-end other than December 31, they have to file the NR6 annually on or before the first day of their fiscal year. Each member of a partnership must file a NR6. The NR6 requires your ITN or BIN.
CRA will accept the NR6 throughout the year, however the effective date for withholding on the net amount will be the first day of the month in which they receive and approve the form. You have to withhold tax on the gross rental paid or credited before that date. There must be a Canadian resident agent noted on the NR6 or it will not be approved. This can be the taxpayer’s relative, accountant or lawyer.
The NR6 requires an estimate of the gross rent less expenses, excluding depreciation. The 25 percent withholding is applied to the net amount, yet if there is a rental loss no withholding is required.
Filing the NR6 obligates the owner to file a Section 216 tax return within six months after the end of the year reporting net rental income for all rental properties. For individual taxpayers, the due date is June 30. If you do not file the return by the due date, the 25 percent non-resident tax will be levied on the gross rental with an assessment issued to the agent.
Filing tax returns
Information about the Section 216 return may be found by obtaining CRA’s “Income Tax Guide for Electing Under Section 216,” publication T4144.
Without filing the NR6, you may still file a Section 216 tax return within 24 months after the end of the taxation year. Any tax withheld and reported on the NR4 slip is credited on the return.
The Section 216 return reports gross rent less allowable rental expenses in accordance with the provisions of the ITA. There are no carryover provisions for rental losses that are available under the IRS Code as net operating losses or passive activity losses. Depreciation otherwise noted as capital cost allowance or CCA on the building, furniture, and fixtures may be claimed to reduce the net rental income to nil. Depreciation may not be claimed to increase or create a tax loss unless certain conditions are met for corporate investors.
For individual investors, federal tax is computed on the basis of graduated tax rates. For 2012, income to $42,707 is taxed at 15%; from $42,708 to $85,414, income is taxed at 22%; from $85,415 to $132,406, income is taxed at 26% and above $132,406, income is taxed at 29%.
Provinces levy a tax on business income, but not on Section 216 returns. In lieu of provincial tax, a federal non-resident surtax of 48 percent multiplied by the federal tax otherwise determined is added to the federal tax liability. For example, if the net rental income is within the first tax bracket, the effective rate is 22.2 percent (15% x 1.48) on net rental income as opposed to 25 percent on the gross.
If you are filing the section 216 return because you filed a NR6, any tax owing is due by the balance-due date; April 30th for individual investors. This could occur if you overstated your expenses or understated gross income on the NR6.
Subsection 216(5) states that if the property is sold, a Section 216 return must be filed by the due date of the return filed under Section 115 of the ITA reporting the sale, if CCA was claimed in a prior taxation year and there is recapture of CCA. Recapture of CCA will occur if proceeds from the sale of depreciable property (building, furniture, and fixtures) are at least equal to the original cost (including additions) and CCA was previously claimed.
If proceeds from the sale depreciable property are less than the original cost, a terminal loss may arise to apply against the net rental income (loss) for that year. The terminal loss may not be applied to capital gains realized on the property reported under Section 115 of the ITA or from net rental income reported in prior years.
For U.S. purposes, rental income is reported on Schedule E of the U.S. 1040. Credit for either the withholding tax or tax computed on the Section 216 return may be claimed on IRS Form 1116.
With a partnership, joint ownership or tenants in common, each co-owner or partner must file their own Section 216 return.
Sale of Canadian Real Estate
Capital gains realized by a U.S. person on the sale of any Canadian real property interest, regardless if it has been rented, will attract Canadian and U.S. tax. One-half of capital gains are subject to Canadian tax for all investors.
The tax return reporting the disposition is due for filing within six months after the end of the year for corporate investors; 90 days for trusts and April 30th for individual taxpayers who are not self-employed. If self-employed, their due date is June 15th. IRS Form 1116 should be filed to claim a foreign tax credit for the Canadian tax.
Prepayment of tax
CRA Information Circular IC 72-17R6 outlines the procedures concerning the disposition of Canadian real estate held by non-residents of Canada.
Section 116 of the ITA prescribes a prepayment of 25 percent on the estimated capital gain on land and building (excluding selling expenses). There is a 50 pecent withholding on recapture of CCA.
The vendor needs to make an application for a clearance certificate on CRA Form T2062 for capital gains and on Form T2062A for depreciable property, whether or not there is recapture of CCA. The due date for these forms is within 10 days after the sale. Filed on the basis of a proposed disposition, one should submit the forms at least 30 days prior to closing. If the purchaser is different, (that is, different from the original person on the form) the actual sales price is higher, or the tax basis is lower from the proposed disposition, you need to send a notice of actual disposition within the 10 day limit.
Individual or corporate vendors need to have their ITN or BIN on these forms. They may submit the T1261 or RC1 with their application. Non-resident trusts are assigned a number when the forms are submitted. The forms are sent to the CRA tax service’s office where the property is located.
The T2062/T2062A enquires about you having ever rented the property or if withholding tax was remitted. If you have not been in compliance with the foregoing rules under Section 212, any potential liability here could hold up the processing of the forms and issuance of the clearance certificate.
Where a non-Canadian partnership is the owner, one T2062/T2062A is filed by the partnership on behalf of all non-resident partners with details on their respective percentage interest in the partnership as well as their addresses, ITN/BIN, percentage of tax basis, proceeds of disposition and their respective payment or security.
Where the property is owned jointly, tenants in either common or co-ownership, must file their own T2062/T2062A with identification numbers.
Details of tax basis including original purchase agreements, schedules indicating improvements, and an allocation between land and building are required with the submission.
Generally the CRA will send a comfort letter to the vendor indicating that the application is accepted and that they will issue a certificate T2064 or T2068 with a certificate limit to the vendor and purchaser. If the application is submitted after the sale, a T2068 will be issued once the funds or acceptable security has been received.
Effectively the certificate relieves the purchaser from having to remit to CRA. Where the vendor has not remitted the tax or acceptable security, the purchaser is obligated to pay the tax on the purchase price (or the purchase price in excess of the pre-transaction clearance certificate), within 30 days after the end of the month in which the purchaser acquired the property.
It is advisable to submit the T2062/T2062A as early as possible to provide sufficient time for processing. An early closing may not give sufficient time to obtain the T2064/T2068.
In practice, where the T2062/T2062A forms have not been prepared and the purchaser’s attorney is not aware that the property was rented or does not have an allocation of land and/or building, he may hold in trust 25 percent of the purchase price. Depending on the facts, CRA could assess 50 percent on the building (including other depreciable property) portion.
Ultimate tax liability
One-half of capital gains net of selling costs are subject to tax. For individuals, the maximum rate on a capital gain is approximately 21.46 percent including the 48 percent non-resident surtax.
One copy of the T2064/T2068 is attached to the Section 115 tax return to claim credit for the prepaid tax.
If you owned the property on Sep. 26, 1980, Article XIII, paragraph 9, of the Canada/U.S. Tax Treaty may allow you to exclude the portion of the gain accruing up to Dec. 31, 1984. Claiming treaty benefits may require CRA Forms NR301, NR302 or NR303.
Compliance is Simple
Although Canadian tax compliance is an added administrative cost of investing in Canadian real estate, it does not have to be complicated.
By not filing returns where you are obligated to do so under Section 216 or just simply avoiding remitting withholding tax on the rental, you create unnecessary delay and risk when you endeavor to complete the sale and obtain the Section 116 clearance certificate.
Properly completed tax returns should generally provide credit for Canadian taxes on your U.S. tax return without the incidence of double taxation. Depending on your annual tax profile, you may have a foreign tax credit carryover.
CRA forms are available on their website at http://www.cra-arc.gc.ca.
Larry Stolberg, CA,CPA,CFP, has been practicing as a full-time tax specialist for over 30 years, with both a U.S. CPA designation and a Canadian Chartered Accountant designation. He has a primary emphasis on corporate restructuring for business owners, state/succession planning, U.S. expatriate and cross-border issues, and tax efficient planning. He has made presentations on various tax and estate planning issues. He can be reached by phone at 647-298-1339 or email Lstolberg@Lnsca.com.