Canadian investors who own residential real estate in the United States should make sure they’re following US tax laws, as the Internal Revenue Service (IRS) may soon be cracking down on non-compliant foreign property owners. This increased scrutiny is due to a critical report issued two weeks ago by the Treasury Inspector General for Tax Administration (TIGTA).
TIGTA, which reports directly to the United States Treasury and is charged with providing independent oversight of IRS activities, examined property ownership by non-residents and concluded that “additional controls are needed to help ensure that non-resident alien individual property owners comply with tax laws.”
The report estimated that non-resident alien individuals’ investment in US property had increased, from USD$34.8bn during the 12-month period ending in March 2013, to USD$43.5bn during the 12-month period ending in March 2016.
TIGTA’s audit was initiated to evaluate the IRS’ efforts in identifying non-resident aliens required to pay tax on rental income of US property, as well as the ability of the agency to address this issue.
If you’re like many foreign vacation property owners, chances are you either rent – or at least attempt to rent –your property when you’re not occupying it. If so, the rental income that you earn may be taxed in both the United States and Canada.
Canadians pay tax at graduated federal/provincial tax rates on worldwide income, including net rental income from US property, after deducting applicable expenses. Canadians can generally claim a foreign tax credit on their tax return for US income taxes that have been paid to reduce the tax that will be payable in Canada.
A 30% US withholding tax applies to gross rental income that you earn from your US property. Keep in mind that your tenant is required to withhold the tax and remit it to the US tax authorities on your behalf.
You could, however, elect to have the rental income treated as “effectively connected to a US trade or business.” By doing this, you can reduce your rental income by offsetting rental income with the various expenses associated with the rental activity, such as property taxes and insurance. The net rental income will be taxed at graduated US federal tax rates. State income taxes may also be applicable.
Even if you don’t rent out your property, when you choose sell, you may face a tax bill on both sides of the border on any appreciated value. A capital gain arises if the proceeds from disposition, net of selling expenses, exceed the cost of the property, including any amounts paid for capital improvements.