In a recent article published in the Financial Post, Jamie Golombek discusses the announcement by the Canada Revenue Agency (CRA) that it will examine the six (6) most recent years of US real estate transactions to identify cases where Canadian residents owning US real estate have not complied with their obligations to report (i) receipt of US rental income, (ii) ownership of US investment property, and (iii) the sale of US real estate. Due to the significant penalties which can be levied for non-compliance with these obligations, we offer you, the reader, an extended overview of standard Canadian tax reporting obligations for Canadians who own US real estate and the penalties which can be triggered if one does not comply with these obligations.
We also highlight certain US taxation and US tax compliance obligations for Canadians who earn rental income from US real estate.
Scope of the Examination
As part of this examination, the CRA has announced that it is seeking a provider to compile information on US real estate data on transactions to which Canadians were parties, whether as buyers, sellers or transferors of some other sort. This information compilation process will allow the CRA to gather information on US real estate transactions involving Canadian residents and cross reference these transactions with the tax returns of the same residents to ascertain if they are in compliance with their Canadian tax filing obligations.
Receipt of US Rental Income
Canadian residents are required to disclose and pay Canadian tax on their worldwide income. This disclosure obligation extends to US rental income, which must be converted to Canadian dollars using the applicable exchange rate between the US dollar (USD) and the Canadian dollar (CAD). A taxpayer who files a late return and owes taxes will be subject to a penalty of 5% on the owed amount, interest at the CRA’s prescribed rate, and an additional penalty of 1% of the owed amount for each month the return is late, for a maximum of 12 months. In case of repeated failure over the course of four (4) years, the penalty is doubled to 10% of the owed amount, with an additional penalty of 2% of the owed amount for each month the return is late, for a maximum of 20 months.
If a taxpayer, knowingly or under circumstances amounting to gross negligence, makes a false statement or omission on his/her return, then a false statement or omission penalty can be assessed. The penalty is equal to the greater of $100 or 50% of the understatement of tax and/or the overstatement of tax credits related to the false statement or omission.
Ownership of US Investment Property
Canadian residents are required to disclose ownership of US real estate and other specified foreign investment with a value of over $100,000 CAD. Specified foreign property includes foreign investment real estate, foreign bank and investments, and interests in foreign businesses. The disclosure of this property is made by filing Form T1135, Foreign Income Verification Statement. Failure to file Form T1135 where required triggers a filing penalty per slip of $25 CAD/day for each day late up to a 100-day maximum for a total penalty of $2,500 CAD per slip, plus interest in arrears. This penalty is independent of whether the taxpayer earned income from US real estate or other specified foreign investment. However, where a Canadian resident owning US real estate solely uses the property for personal purposes, there is no requirement to disclose ownership of the property to the CRA by filing Form T1135.
The remarks in the previous paragraph must however be varied where a Canadian resident owns US real estate through a trust, a corporation, a limited partnership, a limited liability company or another structure. Additional Canadian tax reporting obligations will apply in such case, but these obligations will vary according to the ownership structure. For example, where a Canadian resident owns US investment real estate through a Canadian corporation, a T2 return must be filed for the corporation and the corporation, in turn, must file Form T1135 if the value of the US real estate is over $100,000 CAD. If, however, a Canadian resident owns US investment real estate through a US corporation of which he is the sole shareholder, then no T2 return is required for the corporation, but the Canadian resident must declare ownership of the shares in the US corporation by filing Form T1134, Information Return Relating to Controlled and Not-Controlled Foreign Affiliates. Failure to file any of the aforementioned forms triggers specific per diem filing penalties and, in certain instances, penalties on the owed amount.
If you are a Canadian who owns US investment real estate, whether personally or through a structure such as one of the aforementioned structures, we strongly recommend that you verify with one of our cross border tax experts if you are compliant with your Canadian tax filing obligations and to also assess whether your US real estate ownership structure is tax efficient.
Sale of US Real Estate
The obligation of a Canadian resident to declare worldwide income includes the obligation to declare the sale of US real estate, whether personal use or investment use, and pay Canadian capital gains tax on any gain on the sale. The Canadian capital gains tax liability is levied in addition to FIRPTA withholding and US capital gains tax on the sale.
Remember that, under the US Foreign Investment in Real Property Tax Act (FIRPTA), where a non-resident sells an interest in US real estate, the seller is subject to a mandatory withholding on the gross sale proceeds, which is 15% for foreign individuals, 21% for foreign corporations and 35% for foreign trusts. The FIRPTA withholding is the IRS’s way of ensuring that all foreign sellers of US real estate, who are subject to US capital gains, pay their US tax, if any, in advance. This withholding obligation does not however exempt a non-resident seller from filing a US tax return to declare the sale of US real estate.
In reporting the sale of US real estate, a Canadian taxpayer must convert the purchase price to Canadian dollars (CAD) using the exchange rate on the purchase date and must also convert the sale price to Canadian dollars (CAD) using the exchange rate on the sale date. Fortunately, if the taxpayer has the right ownership structure, the taxpayer can claim both FIRPTA withholding and US capital gains tax resulting from the sale of US real estate to reduce Canadian capital gains tax liability on the sale.
It should be noted that in certain instances, a Canadian resident who realizes a minimal capital gain or no capital gain at all in US dollars (USD) on the sale of US real estate may be subject to Canadian tax on the conversion to Canadian dollars (CAD). For example, a Canadian resident purchases a US property for $200,000 USD when the US dollar (USD) and the Canadian dollar (CAD) are at parity and later sells the property for $200,000 USD when the US dollar (USD) is valued at $1.30 CAD. In such case, there is no capital gain in the United States, but there will be a capital gain of $60,000 CAD, which will be subject to Canadian capital gains tax.
US Taxation and US Tax Compliance Obligations Applicable to Rental Income from US Real Estate
Although this article focuses on the Canadian tax compliance obligations of Canadians who own US real estate, receive income from US real estate and sell US real estate, we nevertheless highlight certain key US taxation and US tax compliance obligations of Canadians who earn rental income from US real estate.
Where a Canadian or any other non-resident under US tax law earns rental income from US real estate, the gross income is ordinarily treated as Fixed, Determinable, Annual or Periodic Income (FDAP), which is subject to withholding at a rate of 30%. However, this withholding can be reduced to the applicable marginal US income tax rate if the property owner files Form W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade of Business in the United States, and provides the tenant or property manager with this form. By filing this form, the owner elects to be taxed on the net rental income (after expenses and depreciation) at marginal US income tax rates and to file a US tax return to declare the income to the Internal Revenue Service (IRS). Provided a Canadian owner of the US rental real estate has the proper ownership structure, he/she can claim the US tax on rental income as a foreign tax credit against Canadian tax on the same income.
If you own US real estate, whether personal use or held for investment purposes, we strongly recommend that you consult one of our experienced cross border tax experts to determine if you are in compliance with your Canadian tax filing obligations. Should you not be compliant, it may potentially be possible to remedy non-compliance with these obligations through the Voluntary Disclosure Program, a program to remedy non-compliance with Canadian tax compliance filings, if you qualify under the program’s criteria.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.
About the author
Shlomi Steve Levy is a Partner of Levy Salis LLP and is a member of the Quebec Bar, the Law Society of Ontario (L3), the Society of Trust and Estate Practitioners, and the Canadian Bar Association.
Sergei Titorenko is an Associate at Levy Salis LLP and a member of the Quebec Bar. He devotes his practice to US and Canadian tax and estate planning, Canadians doing business in the United States, Americans living in Canada, US real estate transactions for Canadians, and cryptocurrency transactions.