Canadians should keep in mind that the sale of any U.S. real property interest will not only attract Canadian tax, but U.S. as well. Canada will generally give you a foreign tax credit for any federal and state tax.
If the sale price is under $300,000U.S. and the property is acquired as a principal residence by the purchaser, the 10% federal withholding tax on gross proceeds is waived. The purchaser must sign an affidavit to this effect. The withholding tax must be remitted within 20 days of the date of closing with IRS Form 8288-A. Specific regulations define the meaning of “principal residence” for purposes of this withholding exemption. Some States like South Carolina have a withholding tax provision.
The PATH ACT that was passed on December 18, 2015 increases the withholding to 15% on real property interests effective 60 days after December 18, 2015 (the date of enactment of the PATH ACT). Where the property is to be used as a residence by the purchaser and the sale price is less than $1MU.S., the withholding remains at 10%. Where the property is not used as principal residence by the purchaser, the withholding will be 15% regardless of the sale price.
These IRS forms require a taxpayer’s identifcation number (“TIN”) for the vendor and also the purchaser where the purchaser is not a U.S. person. You attach the 8288 forms to ITIN application, IRS Form W-7.
For properties held over a year, the maximum federal tax rate is 20% on personal capital gains. If you owned the property on September 26, 1980, the Canada/U.S. Tax Treaty may allow you to exclude the portion of the gain accruing up to December 31, 1984. A treaty position is claimed by filing IRS Form 8833 with your U.S. 1040NR tax return. Most states where the property is situated will levy tax, payable on filing a state tax return. You should consult with the state to determine your obligations.
Tax returns may not be filed until the year following the year of sale. Thus you could end up waiting over a year from the sale date for your refund. You may apply for a lesser amount of withholding tax if you believe the 10%/15% rate will be in excess of your actual tax liability. This application may be more imperative if there is a mortgage on the property and the 10%/15% will have to come out of your pocket.
You may apply for a reduced withholding by filing an application for a withholding certificate on IRS Form 8288-B, that must be received by the IRS by the closing date. You will need an ITIN to properly file Form 8288-B. You attach the 8288-B to your IRS Form W7 with a copy of the sales contract. Once approved, the IRS will notify the assigned withholding agent (sometimes your lawyer or title company) to remit the required amount of tax held in escrow with Form 8288 and 8288-A, within 20 days. The IRS must act within 90 days to process the 8288-B, but it could take as long as 3 to 5 months.
You must file your U.S. individual tax return by the June 15th the following the year of sale.
Where real estate interests are held through a partnership, trust or corporation, similar rules apply.
For example, the FIRPTA rules in Section 897 of the IRS Code and Regulations will also affect the movement of the shares of a Canadian corporation where US real property held by Canco is greater than 50% of total fair market value of assets, with a 5-year look-back rule. Movement to distribute real property to the shareholder may or not be a tax-exempt transaction for US tax purposes but may not be for Canadian tax purposes. Professional advise should be obtained to determine the compliance requirements and the combined U.S. & Canadian tax implications.
Some states such as South Carolina have withholding requirements on the transfer of US real property held by non-U.S. persons.
Other concerns for Canadians
Transfers by way of gift of a real property interest for no consideration will require a gift tax return IRS Form 709 filed by the donor if the value of the value of their annual gifts (subject to U.S. gift tax) exceeds their annual exemption of $15K or in the case of a transferee non-U.S. spouse, $152K ($155K-2019). No notice (ie, IRS Form 8288) nor any withholding is required.
However if there is part consideration such as cash paid and indebtedness assumed, then this aggregate amount represents proceeds of disposition and consequently, withholding and notice is required. The capital gain would be the proceeds less adjusted basis. A withholding certificate may be beneficial to reduce or eliminate any withholding.
The Canadian tax implications need to be considered here to determine credit for the U.S. tax payable per the U.S. tax return. Credit would be available to extent of the effective Canadian tax on the sale. Any excess U.S. payable that is not creditable due to our limitation, is not deductible against net income because the capital gain from the sale is not regarded as income from business or property for Canadian income tax purposes. If the transferor had other U.S. source income, then there could be credit utilized from the sale.
Spousal transfers of U.S. real estate may not result in any gain recognized if an election is not made to opt out of the Canadian rollover pursuant to subsection 73(1). In this situation, one may have U.S. tax on the transfer and no Canadian tax until the property is sold to a third party, resulting in double taxation.
U.S. forms are available on the IRS website (at http://www.irs.ustreas.gov/pub).
Contact your professional advisor prior to implementing any of the outlined strategies.
Internal Revenue Service Circular 230 Disclosure
Pursuant to Internal Revenue Service Circular 230, we hereby inform you that the advice or information set forth herein with respect to U.S. federal tax issues was not intended or written to be used, and cannot be used, by you or any taxpayer, for the purpose of avoiding any penalties that may be imposed on you or any other person under the Internal Revenue Code.