American citizens living in Canada are no strangers to tax compliance obligations. A quasi example is selling a Canadian principal residence. Some tax obligations are simply a result of triggering the Canada/US tax treaty, while others can give rise to US taxation in cases where exemptions are in place in Canada.
With the ongoing surge in real estate prices, more and more homeowners are opting to sell their properties, yielding significant capital gains. However, there is a stark contrast in tax benefits between Canadian tax residents and US citizens (or long-term green card holders) residing in Canada. While Canadians can leverage the Principal Residence Exemption to secure a tax-free gain when selling their homes, Americans living in Canada still find themselves liable to US taxes.
The unlimited Canadian Principal Residence Exemption
In Canada, the principal residence exemption can be utilized to eliminate or minimize (for income tax purposes) the capital gain arising from the sale, transfer, or gifting of a taxpayer’s primary residence, whether it occurs upon the taxpayer’s death or through a legal transaction.
For a property to be designated as the taxpayer’s principal residence and for the taxpayer to claim the principal residence exemption the following conditions must be respected:
- As per the provisions of the Income Tax Act (“ITA”), a taxpayer is entitled to claim the principal residence exemption on one (1) property per year.
- The taxpayer must own the property (note that joint ownership with another person may qualify as well).
- The taxpayer, their spouse or common-law partner, former common-law partner, or a child of the taxpayer must have resided in the housing unit as their primary residence during that particular year.
- The taxpayer is required to file the T2091 form, designating their home as their principal residence, for each relevant tax year that they are seeking to claim the exemption.
The limited US Principal Residence Exemption
According to US tax regulations, the maximum capital gain exemption on the profits derived from the sale of a primary residence is set at $250,000 USD for those filing taxes individually (or $500,000 USD for married couples filing jointly), and any amount exceeding this threshold is subject to taxation. Depending on your income, the sale of this property will be subject a capital gain tax of up to 20% and an unavoidable net investment income tax (NIIT) of 3.8%. However, it is important to note that this exemption is conditional and subject to the following terms:
- Ownership Requirement: The seller owned the property for at least 24 months (2 years) out of the five (5) years leading up to the date of sale.
- Residence Requirement: The seller used the property as his/her residence for at least 24 months during the five (5) years leading up to the date of sale.
Given this limited US exemption, many US citizen (or long-term green-card holders) living in Canada face a heavy US tax burden on the sale of their Principal Residence.
Let’s consider the following scenario: McGill University professor and US citizen, Dr. Smith, moved to Montreal in 1978 with his wife, a Canadian citizen. Upon settling into the city, the couple jointly purchased a property for $300,000 CAD. Today, the couple wishes to sell their home. The current fair market value of the property is 3.3 million dollars Canadian. The home qualifies as the couple’s principal residence in accordance with the definition set forward in the Canadian Income Tax Act, therefore, they are not subject to taxation on the capital gains in Canada.
Seeing as Dr. Smith is a US citizen, he would be subject to a US capital gain tax on his attributable gains resulting from the sale of the property. The US capital gain tax in the case of Dr. Smith is twofold; first the sale is exposed to a 20% capital gain tax (the maximum amount assumed) and second, a 3.8% net investment income tax (NIIT). The US principal residence exclusion for a single tax filer is $250,000.00 USD. Assuming an exchange rate of 1.34 Canadian/US Dr. Smith may be liable for $654,500.00 CAD for US capital gains tax upon the sale of his Canadian principal residence.
With careful planning, it is often possible to reduce the burden of taxes in most situations.
Since the property is jointly owned (50% from the US citizen husband and 50% from the Canadian citizen wife), one option would be for the US citizen to transfer their 50% interest in the property to their Canadian spouse, which would qualify as a tax-exempt gift under the limited marital annual exclusion of $175,000 USD in 2023 on the US side. Additionally, this approach would not encroach upon the individual’s lifetime US gift tax exemption that is set in 2023 as $12.92 million USD for an individual. On the Canadian side, the transfer of the husband’s ownership in the property to his wife is subject to a spousal rollover exemption allowing the property to be transferred on a tax-deferred basis. Once the Canadian spouse is the owner of 100% of the property, assuming they elected the property as their principal residence for the appropriate tax year, the eventual sale to a third party would not be subject to taxes on the capital gain. Please be aware that this particular option comes with one crucial prerequisite that we unfortunately cannot help you with: a happy and healthy marriage!
Another option is applying the capital loss carry forward principle. This principle refers to a provision that allows taxpayers to offset capital losses against future capital gains or other taxable income. When an individual or business incurs capital losses from the sale or disposition of certain assets, such as stocks, bonds, real estate, or other investments, the losses can be used to reduce taxable income. More specifically, if the total amount of capital losses exceeds the capital gains in a given tax year, the excess loss can be carried forward to future tax years and used to offset capital gains and potentially reduce taxable income. This is known as a capital loss carry forward. Continuing the example of Dr. Smith, let us assume that in 2022 he claimed $100,000 USD of capital loss resulting from a variety of their assets. His capital loss carries forward from 2022 to offset the US capital gain that followed the sale of his property in 2023 (calculated previously) by $100,000 USD.
A potential option for US residents living in Canada who wish to avoid US taxation is to consider expatriation from the United States. This involves renouncing their US citizenship and being subject to the expatriation tax, which is based on the value of their assets and the length of their US residency. However, it’s important to note that the process of expatriation has substantial consequences and requires careful evaluation before making a decision.
It is worth noting that a property situated in the United States can also qualify as an individual’s principal residence and be eligible for the Canadian Principal Residence Exemption. However, it is crucial to be aware that utilizing the exemption for the American property may impact the exemption eligibility for any other Canadian property, up to the number of years during which the US property was deemed the taxpayer’s principal residence. Therefore, if an individual owns two properties simultaneously, it is essential to determine which property should benefit from the principal residence exemption.
Moreover, if a US citizen possessing property in the United States becomes a Canadian resident, the cost basis of the property (e.g., purchase price for tax purposes) would be established as the property’s market value on the date the US citizen becomes a Canadian resident. Any unrealized gain accumulated on the property until that point would not be subject to taxation in Canada, but rather in the US
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With our extensive knowledge and experience in cross-border tax planning, the dedicated team at Levy Salis LLP is well-equipped to help you with this evaluation. We are more than happy to discuss your unique personal and professional circumstances, as well as the potential opportunities that lie ahead. Take advantage of our complimentary consultation, where we can provide valuable insights and guidance for all your tax planning and cross-border needs. Don’t hesitate to reach out to us today!
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.