The article “What are the tax implications of selling U.S. real estate?” was originally published in MoneySense on October 31, 2022. Photo by Kampus Production from Pexels.
Mary and Vic are selling a property in the U.S. and want to know what the capital gain tax implications are on both sides of the border. Here’s how it works.
“We are selling our U.S. park home in Mesa, AZ. It has increased by about USD$47,000. Would we have to pay capital gains or any taxes in Canada or the U.S.?” Mary & Vic
Tax implications of selling U.S. real estate
Canada taxes its residents on worldwide income. This means income in other countries is generally taxable in Canada. The U.S. taxes the sale of U.S. real estate by non-residents. So, Mary and Vic, a Canadian selling U.S. real estate can have tax implications in both countries.
What are the U.S. tax implications?
The U.S. government allows exemptions from capital gains tax for real estate in certain circumstances. Similar to the principal residence exemption in Canada, there is a principal residence exclusion in the U.S. It allows a capital gains tax exclusion of up to $250,000 of the capital gain on the sale of a qualifying home. For a couple, the exclusion is doubled to a total of $500,000.
U.S. taxpayers can also postpone paying capital gains tax if they sell a rental or business property and replace it with a similarly valued property. This is called a like-kind exchange.
The state of Montana even has a capital gains exclusion from the sale of a mobile home park. But, Mary and Vic, there are no capital gains exclusions for Canadian residents selling real estate in Arizona. Your USD$47,000 capital gain would be taxable to you in the U.S. in the year of sale.
The U.S. distinguishes between short- and long-term capital gains, and it charges different tax rates for each. As long as you have owned the property for more than a year, you will qualify for the lower long-term rate, with a maximum of 20% tax payable.
When you sell the property, a U.S. attorney will be required to withhold and remit 15% of the proceeds as withholding tax to the Internal Revenue Service (IRS). You may qualify for a withholding tax rate of 0%, if the sale price is under $300,000, or at a rate of 10%, if the price is between $300,000 and $1 million. That is assuming the buyer intends to occupy the home as a residence more than 50% of the time over the next two years. You may also be able to apply to the IRS to reduce the withholding tax if the tax payable would be significantly less than 15% of the proceeds.
Regardless, you will have to file a U.S. tax return to report the sale. You may be entitled to a refund or have some additional tax to pay. You will need to apply for a U.S. Individual Taxpayer Identification Number (ITIN) if you do not have one already. It is like a Social Security Number (SSN) for a non-resident (similar to a Canadian Social Insurance Number (SIN) that identifies you for tax purposes).
The U.S. tax withheld is eligible to be claimed on your Canadian tax return as a foreign tax credit. This helps avoid double taxation.
What are the Canadian tax implications for selling U.S. real estate?
You will have to report the sale of the property in Canada as well. You may have had a USD$47,000 capital gain on the sale, but the Canadian capital gain or loss may differ. This is because you need to consider the purchase price in Canadian dollars as well as the sale price in Canadian dollars, based on the foreign exchange rates at those times. If the foreign exchange rate changed significantly, you could have a smaller or larger capital gain in Canada, or possibly even a loss.
The top tax rate in Canada for a capital gain is 27%. So, the U.S. tax is likely to be well below this amount and can be claimed as a foreign tax credit to reduce the Canadian tax payable.
Interestingly, a Canadian resident can claim the principal residence exemption on the sale of a property in the States, or any other country, for that matter. The exemption is available for any property that you ordinarily occupy, not necessarily the place you primarily live. It would be uncommon to claim the principal residence exemption for a vacation property mainly because such properties tend to be valued less than a primary place of residence.
If you claim a principal residence exemption for a U.S. property sale, you are then exposing any other real estate you own to capital gains tax when you sell it. For example, Mary and Vic, ff you owned the Arizona property for 10 years, claiming it would expose 10 years of your Canadian home’s appreciation to capital gains tax in the future.
There’s another drawback to the principal residence claim approach. If you have U.S. tax payable on the sale, but not Canadian tax, you may not be able to recover the U.S. tax paid. The IRS doesn’t care whether you pay tax on the capital gain in Canada, and the U.S. tax is a non-refundable tax credit in Canada.
Selling property internationally
In summary, Mary and Vic, you may have tax withheld upon the closing of the sale of your Arizona property. There is the possibility of filing for an exemption, depending on the intention of the buyer, the sale price and the capital gain. You will have to file a U.S. tax return to report the sale and may have tax to pay or may get a refund. You will have to report the sale on your Canadian tax return and may be able to claim the U.S. tax paid as a foreign tax credit to avoid double taxation.
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.