Non-resident owners of personal use or rental properties will pay capital gains tax on sale but there are a grocery list of compliance rules for rental properties. Rental payments to non-residents are subject to with- holding tax. The owner(s) must submit an NR6 asking to be exempt from withholding taxes within 30 days of purchase and request Non-Resident tax numbers to be issued. They must also designate a Canadian resident as their “Authorized Agent”. If they are not waived from withholding 25% of gross rents, then they are required to withhold 25% or any lesser amount designated by the CRA of the gross rent paid and remit it to Receiver General of Canada by the 15th of the month following receipt of rent.
Usually an automatic monthly payment from the checking account to the CRA is set up. The non-resident owner(s) must then file, by December 31st of each year, the Form NR6 application with the CRA which includes a projected rental statement showing no or little net rental income – – common where there is a high mortgage – – in which case they will be exempted from withholding tax on the monthly rent. The non-resident must prepare and submit an NR4 slip and NR4 slip summary to the CRA by the end of February each year declaring the gross rents collected in the prior year. The non-resident is not required to file a tax return if they have remitted 25% of the gross rents monthly. So they can opt out of filing a s. 216 tax return enclosing a T776 Rental Statement if 25% of gross rents have been submitted monthly but it is almost always favourable to do the tax filing as they will almost always get a refund on the withholding taxes as the taxes on the net rental income will be lower than the withholding taxes. There is usually a refund as you have off-setting expenses and the first $43,561 in 2016 of income is taxed at the lowest rate of 20.05%. A Section 216 non-resident return must be filed by June 30th and separately for both owners if there is joint ownership.
If you are exempted from withholding tax by the CRA, you must file a s. 216 non-resident rental filing by the June 30th deadline. You are taxed on net rental income from at the lowest rate of 20.05% up to $43,561of net rental income. So, if rent is $1,600 a month and you withhold and remit $400 monthly, you will have sent in $4,800 of taxes and need not file. If you DO file and net rental income is $10,000, you will pay $2,005 of taxes based on the 20.05% rate; thus, a $2,795 refund. This is also why non-residents should buy jointly with their spouse as they will split the net rents and the taxable capital gain – – one-half of the actual capital gain – – on sale and keep all or most of the taxable capital gain in the lower tax brackets on sale. A designated agent is required to sign the NR6 and withhold and remit 25% of the gross rents or whatever amount the CRA stipulates – – it can be less than 25% – – if they are not exempted from with-holding taxes based on the NR6 application. If the non-resident fails to file the tax return within the 6 months of the year-end, the agent is liable for any taxes less amounts actually remitted. Most foreign investors have enough equity in their investment that they will get a filing done and the requirement for withholding tax on sale will ‘catch’ any delinquent taxes so an “authorized agent” does not truly face any risk. (SEE BELOW).
Generally, the Income Tax Act requires prepayment of income tax attributable to sales of Taxable Canadian Property (TCP) by non-residents. Non-residents will pay capital gains tax if there is a gain on the sale of a rental property, a personal use property such as cottage and on a condo bought for usage by one of their children attending local universities. The purchaser of the property from the non-resident must withhold 25% of the purchase price and remit it to the CRA within 30 days from the end of the month of the purchase if the vendor does not provide a Tax Clearance Certificate Form T2068 on close of the sale.
The non-resident vendor may make an application to the International Tax Division of the CRA no later than 10 days after the close of the sale using Form T2062 which is an application for a Tax Clearance Certificate (TCC) which will require that the vendor lawyer to send ONLY 25% of the difference between the Adjusted Cost Base – – cost, plus LTT, plus legal fees and any capital improvements – – and Sales Proceeds without deducting real estate commissions or legal fees. On a `differential’ of $100,000, the vendor’s lawyer would remit $25,000 as designated by the CRA in the Tax Clearance Certificate to the CRA within 10 days of the close. With an Adjusted Cost Base of $300,000 and a sale price of $400,000, a non-resident vendor would be required by the purchaser’s lawyer to remit $100,000 – – 25% of the sale price – – to the CRA if no TCC had been obtained and the vendor lawyer does not provide an undertaking to submit a T2062 application within 10 days of the close. If a TCC is obtained, the CRA would require that only $25,000 be remitted, that is one-quarter of the differential.
The Tax Clearance Certificate will have a ‘certificate limit’ of $25,000 based on the calculation above. Make the T2062 application in a timely fashion or there might not be much money left over once any mortgage is paid off if 25% of the sale price is withheld. Our firm is usually contacted by the vendor’s lawyer once the Agreement of Purchase and Sale is finalized and we do a quick submission of the T2062 application with the hope that the CRA provides a TCC by the date of the close. This is rare as the CRA is now saying that it takes a minimum of 3-4 months to process the application so it only works with a really long closing date. Usually, the vendor lawyer will hold 25% of the sale price in trust until the Tax Clearance Certificate is received at which point the lawyer will remit the 25% of the ‘book gain” specified in the TCC then pay out the remainder to the vendor client. Unless there is a huge capital gain on sale, there will be a tax refund with or without the Tax Clearance Certificate but if you are forced to send in 25% of the sales price, there will be a massive refund coming and for a sale early in a year, you will wait until the summer of the following year to get the refund.
A section 115 return is due by June 30th and is filed for the year of sale calculating the “taxable capital gain” while a s.216 filing for rental income is submitted for the year covering the period from January 1 up to the date of the sale. The s.115 filing is separate and each owner must file if there is more than one owner and required as a non-resident will pay capital gains tax on a gain on both of a rental property or a personal-use property.
Recent Canadian legislation, effective as of 1996, requires Canadians to disclose specified foreign assets held outside Canada, if the total fair market value exceeds $100,000. This is called the “Foreign Asset Declaration” and is discussed as No. 4 under “Tax Planning” below. The purpose of the declaration is to track assets outside Canada to ensure that worldwide income on property is being reported and for capturing all assets for departure tax upon emigration or tax on deemed dispositions upon death. Foreign rental properties worth more than $100,000 alone or combined must be reported. Assets not included are those used in active business of the reporting person and personal use assets of the reporting person including personal homes.
Many Canadians have rental properties in the U.S. as well as personal homes. All rental income and gains on the sale of realty in the U.S. must be reported in Canadian tax returns. This income is reportable in a U.S. federal tax return – – some states require state filings where tax will be levied – – and is taxed first in the U.S. since the U.S. is the `source’ country. You are required to file a 1040NR U.S. federal income tax return and, since the 1996 filing, obtain a Taxpayer Identification Number (TIN) from the IRS even if you have used a U.S. Social Security Number for previous filings. You must discontinue using the SSN.
The rules for depreciation of rental buildings differ. In Canada you cannot use depreciation to create or increase a loss. In the U.S. you must take the prescribed depreciation in the annual rental filing and carry forward any losses to apply against gains on sale. The U.S. has draconian non-compliance provisions for non-residents and U.S. citizens who do not file. Failure to file can result in being taxed on the gross rents during ownership on an annual basis with no right to reduce tax based on operating expenses or depreciation. On sale, you will be imputed to have claimed the prescribed depreciation annually, then taxed on the recapture as ordinary income to the extent this imputed depreciation reduces your cost base of the property below original cost. You will also pay capital gains tax to the extent the proceeds of sale exceed your original cost. Any federal and state taxes paid in the U.S. can be used to offset Canadian taxes through the Foreign Tax Credit Schedule on Capital Gains in the Canadian return. The US requires purchasers to withhold a portion of the purchase price which is remitted to the I.R.S. when buying real estate from non-residents of the U.S. Note that in the event of death, you are subject to estate taxes in the U.S. but under the U.S.- Canada Tax Treaty the exempt amount is rising to $600,000 (U.S.) pro-rated based on the proportion that your U.S. holdings represent of your world assets.
Canadian residents emigrating have to consider the tax impact of retaining a Canadian residential property. The Principal Residence Election is an annual election and upon emigration, by definition is not available to non-residents. Therefore, for each year the emigrant owns the Canadian residence, a larger percentage of the gain on the sale will be a taxable capital gain because of the averaging effect of the Principal Residence Designation Form T2091.
They need to consider the consequences of selling the Canadian residence versus changing its use to rental property. You can file a s. 45 election under the ITA to postpone taxes for Canadian purposes on the deemed disposition. But as per U.S. taxes, if the immigrant to the U.S. rents out the Canadian property, the property is classed as an investment property and will not qualify for the U.S. residential tax exemption. Under U.S. rules, the cost basis for calculating gain on sale is the original cost not FMV at the date of the conversion of use to rental usage. Upon sale, all of the gain will be taxable in the U.S. tax return. This also true for rental properties as their cost base for U.S. tax purposes is their original cost. You will also be taxed in the U.S. for capital gains purposes on the original cost of any homes or cottages in Canada if you sell them after becoming a U.S. resident. So sell ALL of your Canadian real estate, stocks and mutual funds before moving to the U.S. and buy a new home, a second home and invest in rental properties, stocks and mutual funds in the U.S [Show this material to your real estate agent.].
Canadian tax rules are based on residency which requires living in Canada for at least 183 days a year with a “settled intention” to remain here. U.S. tax rules, in contrast, are based on citizenship AND on residency if you take up residency in the U.S. although both jurisdictions tax based on worldwide income with the source country taxing first and foreign tax credits provisions to offset or reduce double taxation in the other country.
Immigrants to Canada are deemed to have acquired capital assets owned at the date of immigration at FMV at that date. This is much fairer than the U.S. rule. The FMV on arrival in Canada will be the basis against which gains will be subsequently calculated for Canadian capital gains tax purposes. Excepted from this rule is Taxable Canadian Property owned by the immigrant on the date of immigration which includes: 1) real property situate in Canada; 2) capital property used to carry on a business in Canada; 3) certain shares in public corporations; and 4) any Canadian resource property
The Canadian and U.S. governments are freely exchanging information as part of reciprocal assistance to enforce the tax laws of the countries. The U.S. has built up a huge computer database of real property transactions in the U.S. Revenue Canada has access to this information. Conversely, there are an estimated 250,000 residents of Ontario who have U.S. citizenship OR are deemed to be U.S. citizens if born in the U.S. The I.R.S. now has access to Canadian data. The I.R.S. has been recently mandating that these U.S. citizens – – ‘Overseas Filers’ of U.S. taxes – – satisfy U.S. tax compliance rules and file the current U.S. return along with the prior 6 years’ worth of filings. Only a small fraction of U.S. citizens in Canada have been complying. Under the Canada/U.S. Tax Treaty, each country will exchange full information and will act reciprocally in collecting tax balances for the other country.
A recent controversy has arisen over those Americans living outside the U.S. who, aside from the Overseas Tax Filings to the IRS, have not done the informational filing of the “Foreign Bank Account Report” (FBAR) filed annually in the U.S. The FBAR requires an annual filing declaring all accounts including RRSP, TFSA, RESP, trust, investment, pension and bank accounts. You must identify the institution, the account number, type of account and provide the highest balance in the year. Even though this is a mere informational filing purportedly intended to track tax evaders – – as though they would include secret accounts in the filing???? – – Americans in Canada and around the world who are delinquent in filing FBARs are facing a 25% penalty on the highest balance in EACH account since the year 2003. Again, that is a 25% penalty on the HIGHEST BALANCE in every account since 2003 for the simple failure to file FBARs. An amnesty on late filers expired on September 8th of 2014. The vast majority of U.S. citizens in Canada are delinquent.
Jim Flaherty, our former Minister of Finance, had the courage to fire off a strong letter to the U.S. government that this would be a draconian practice and catch honest tax-filing American citizens living in Canada. He correctly pointed out that the intention of this compliance requirement was to track tax evaders, the bad guys such as those caught in the Swiss UBS scandal with millions stashed away in that bank with the active assistance of UBS. It was never intended to target honest, tax-compliant American citizens living outside the U.S. Good on you Flaherty!
The U.S. Ambassador to Canada made an announcement that some relief might be made available. He announced that U.S. citizens who are “tax-compliant” in Canada – – which means filing accurate Canadian returns and declaring their world income – – could be allowed to get current on their Overseas filings which declare world income in their U.S. 1040 personal tax filings and pay any outstanding taxes and interest and who also complete the FBAR filings back to 2003 MIGHT be waived from the 25% penalties on delinquent FBAR filings. By 2016, the IRS has moved to a position of requiring only the last 6 years of tax returns and FBARs but has not set out what relief will be given on the 25% penalties.
Americans filing the 1040 Overseas filings get an employment exemption if working and can use Canadian taxes paid for the purposes of a foreign tax credit on employment, pension, investment and other income. High earners will still face a tax bite as, beyond a certain level of taxable income, they can use foreign tax credits to offset only the first 90% of Alternative Minimum Tax (AMT). AMT is a 26% tax on income beyond a certain threshold. Once over the threshold, Canadian taxes paid eliminate only 90% of the 26% AMT rate leaving a 2.6% AMT liability for high earners. That is $260 (U.S.) of tax for each $10,000 (U.S.) of income above the threshold. The AMT threshold cuts in at a much lower point for retirees. Yes, it is complicated but our firm does U.S. 1040 returns, U.S. 1040 NR (Non-Resident) returns and the FBAR informational filings. Call us and we would be happy to explain it to you.
This ‘scandal’ is still to be resolved so watch the press and other media for developments from the U.S. end If the I.R.S. does start levying the FBAR accounts with a 25% penalty, there will be hell to pay with American citizens living in Canada, with the Canadian government, with the media and a lot of U.S. Senators and Congressional members will get angry demands from Americans in Canada demanding relief. A 25% penalty would put a big hole in investment accounts and amount to the U.S. taxing Canadian pension, RRSP. RRIF and even bank accounts and, in the long run, there would be a big decrease in Canadian taxes collected from Americans living in Canada as their wealth and income generated therefrom would drop.