The article “Tax planning for Canadians who invest in the U.S.” was originally published on MoneySense on June 10, 2021. Photo by Karolina Grabowska from Pexels.
There are good reasons for Canadians to invest in the U.S., including portfolio diversification. Just keep these tax-planning and compliance requirements in mind.
It’s no surprise that many Canadians invest south of the border—both in stocks and real estate. On the world stage, economically speaking, we’re small potatoes. As of May 31, 2021, Canada’s country weight within the MSCI All Country World Index was less than 3%. By comparison, U.S. stocks represented almost 58%.
The average Canadian home price in April 2021 was $695,657. In Canadian dollars, the average price of a U.S. home was significantly less expensive, at $535,194 (US $435,400).
But before you jump into U.S. investments, know there are both Canadian and U.S. tax implications for a Canadian investor to keep in mind.
Stocks and ETFs
When a non-resident invests in U.S stocks or U.S.-listed exchange traded funds (ETFs), the standard withholding tax on dividends is 30%. A Canadian resident is entitled to a lower withholding rate of 15% under a treaty between the two countries if they have filed a form W-8 BEN with the brokerage where they hold the investments.
The 15% withholding tax is generally the only tax obligation a Canadian investor has to the Internal Revenue Service (IRS) unless they are a U.S. citizen. (U.S. citizens who reside in Canada must file U.S. tax returns as well as Canadian tax returns.)
If a Canadian resident who is not a U.S. citizen sells a U.S. stock or ETF for a profit, realizing a capital gain, they do not pay tax on that gain to the U.S. government.
Dividends, interest, capital gains and other investment income
U.S. dividends, interest, capital gains and other sources of investment income are taxable on a Canadian resident’s T1 tax return because Canadians pay tax on their worldwide income.
Interest income earned in the U.S. generally has no withholding tax for a Canadian resident.
Any U.S. tax withheld on other sources of investment income is eligible to claim as a foreign tax credit. This generally reduces the Canadian tax otherwise payable dollar for dollar, and avoids double taxation.
U.S. dividends, interest, and capital gains must be reported in Canadian dollars based on the applicable foreign exchange rate. Most people use the average rate for the year to convert their income to Canadian dollars, but it is also acceptable to use the rate on the date of the transaction.
Capital gains are a little trickier than dividends and interest because you have at least two exchange rates to determine: the exchange rate on the date of purchase, and the exchange rate on the date of sale. Because exchange rates fluctuate, it is possible that the shift in exchange rates causes a much different capital gain or loss in Canadian dollars than in US dollars.
If an investor has purchased shares at different times, there is even more work involved. You need to figure out the exchange rate for each purchase in Canadian dollars to determine the adjusted cost base. This can be particularly challenging for someone who has a stock savings plan with a U.S.-based employer where they buy shares with each paycheque, for example.
Canadian-listed ETFs and Canadian mutual funds that own U.S. stocks are themselves considered to be Canadian residents, just like an individual taxpayer. They will be subject to withholding tax before a dividend is received by the fund. This withholding tax is generally reported on a T3 slip (or sometimes a T5 slip, depending on the fund) and can likewise be claimed for a foreign tax credit in Canada.
So far, these comments apply to non-registered, taxable investment accounts. There are slightly different implications if a Canadian buys U.S. stocks or ETFs in a different account.
Registered investment accounts
Tax-free savings accounts (TFSAs), Registered Education Savings Plans (RESPs), and registered disability savings plans (RDSPs) generally have the same withholding tax implications by the IRS as a taxable account. However, because these accounts are tax-free or tax-deferred, there are no tax implications for a Canadian beyond the withholding tax.
Does this mean you should not own U.S. stocks in a TFSA, RESP or RDSP? No, but it does mean there is a slight cost to doing so, albeit for the benefit of holding a more diversified investment portfolio.
A Registered Retirement Savings Plan (RRSP) or similar tax-deferred retirement savings account gets special treatment by the IRS. There is generally no withholding tax if you own U.S. stocks or U.S.-listed ETFs. However, if you own a Canadian-listed ETF or Canadian mutual fund that owns US stocks, the tax is withheld before it gets to the fund or to your RRSP.
For a Canadian taxpayer, the tax implications are identical whether you have an account in Canada or the U.S. The physical location of the account does not matter.
Canadians who invest in U.S. real estate face different implications depending upon whether the property is for personal use or is a rental property.
A personal-use property generally has no annual tax filing requirements, whereas a rental property must be reported in both Canada and the U.S. each year.
Rental income and expenses should be reported on both a Canadian and a U.S. tax return. A Canadian resident with a U.S. rental property must file a 1040-NR tax return to report the U.S. source income to the IRS. Any U.S. tax payable can generally be claimed in Canada as a foreign tax credit to reduce Canadian tax otherwise payable.
Upon sale, there may be a capital gain or loss in Canada and the U.S. The Canadian gain or loss depends on the purchase price in Canadian dollars and the sale price in Canadian dollars, based on the exchange rates in effect at the time of each transaction. Purchase and sale costs, as well as any renovations, may reduce a capital gain (or increase a loss).
A Canadian is generally subject to 15% withholding tax on the gross proceeds of U.S. real estate, unless they file for a withholding certificate prior to closing to reduce the tax based on the estimated capital gain. U.S. capital gains tax paid is eligible to claim in Canada as a foreign tax credit.
If a Canadian taxpayer has more than $100,000 in foreign assets, including U.S. stocks, ETFs, rental real estate, or other investments, they need to file the T1135 Foreign Income Verification Statement form with their Canadian tax return. The $100,000 limit relates to the cost, in Canadian dollars, for the investments. Personal-use foreign real estate, as well as tax-sheltered RRSPs or tax-free TFSAs, do not need to be reported.
These are just some of the basic tax implications for a Canadian investor who owns U.S. assets. Investing in U.S. stocks, ETFs or real estate can help diversify a portfolio, but comes with additional complexity and tax-compliance requirements as well.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.