Although many Canadians are taking advantage of low U.S. real estate pricing and the strong Canadian dollar to buy U.S. vacation properties, there are many others who have decided to sell their southern homes.
It might be due to a financial need, limited use as health declines in older age or an upgrade to a larger home. Whatever the reason, there are a number of things your client should know before the sale.
On the U.S. side, under the Foreign Investment in Real Property Tax Act (FIRPTA)—where the seller is a U.S. non-resident alien—the buyer must generally withhold 10% of the gross proceeds and remit it to the IRS as a prepayment of the seller’s tax.
This requirement applies irrespective of the amount of gain, and even if there is loss on the property. However, there are two exceptions that would reduce or even eliminate this withholding tax:
- 1. If the property is sold for less than US$300,000, and the purchaser intends to use it as a principal residence, withholding tax is not required.
- 2. If the vendor’s expected U.S. tax liability is less than 10% of the proceeds, he can apply for a reduced withholding amount (or no withholding if there is no gain) using IRS form 8288-B. Information and documentation in relation to the purchase price, the cost of additions and a copy of an accepted offer must be included with the application.One more thing: the vendor will need an Individual Taxpayer Identification Number (ITIN) to submit form 8288-B. If your client doesn’t have an ITIN, a W7 application should be completed and submitted (with appropriate notarized support) along with form 8288-B.Even if your client applies for a reduced withholding certificate, it’s quite possible the sale will close before receiving approval from the IRS. That means the purchaser will have to withhold 10% of the proceeds.
Even so, if the seller provides the purchaser with evidence of having applied for a withholding certificate, the 10% amount can be held in an escrow arrangement, pending receipt of the IRS approval or denial. The quicker clients submit the reduced withholding application, the quicker they’ll get back any excess withholding.
If your client doesn’t apply for reduced withholding, he’ll have to wait until his U.S. non-resident tax return (1040NR) for the year of sale—due by June 15 of the following year—is processed and assessed to get the excess tax back.
A U.S. tax return must be filed to report the disposition regardless of any reduced withholding under FIRPTA and any FIRPTA amount withheld is considered to be taxes paid. The current U.S. rate on long-term capital gains (assets held more than one year) is currently a maximum of 15%; increasing to 20% in 2011.
The disposition of a U.S. vacation property must also be reported on your client’s Canadian return and any U.S. tax paid (as reported on the 1040NR) is eligible for foreign tax credit in Canada. However, the gain or loss for Canadian purposes may be very different than the amount reported on the U.S. return. This is because the exchange rates used to report the transaction in Canada are those in effect at the time of purchase and sale respectively.
As a result of the strength of the loonie over the last few years, it’s possible the Canadian gain will be much less than the U.S. gain, which may mean the U.S. tax paid will not be fully credited against Canadian taxes.
Your client may even end up with a loss for Canadian tax purposes and losses on personal property are not deductible.
Gena katz, FCA, CFP, an executive director with Ernst & Young’s National Tax Practice in Toronto. Her column appears monthly in Advisor’s Edge