5 Things Canadians Need To Know About Buying US Real Estate
Hi, my name in Allan Madan; I’m a chartered accountant and tax expert in the Mississauga , Oakville and Toronto regions of Ontario, Canada. If you own US real estate, or are planning on buying US real estate as a Canadian, you ought to go through this write-up.
1. Taxpayer Identification Number
The first thing you need to know is that you have to apply for an individual taxpayer identification number, and you need this number every time you file your taxes with the US IRS. To apply for an individual tax payer identification number, complete ‘form W-7’ which can be found on the IRS website. Attach with form W-7, a notarized copy of your Canadian passport. You can get your passport notarized by the Canadian passport office or by an IRS acceptance agent.
2. Withholding Tax
The second thing Canadians need to know about buying US Real Estate is withholding tax. The IRS levies withholding tax of 30% of the rents that you collect. For example, if you own a property in the United States and your gross monthly rent is a thousand dollars, then 30% (or $300) must be remitted to the IRS in the form of withholding tax. That does not seem really fair because it does not take into account any expenses incurred in connection with running the property. So, how do you get around this? This brings us to the third point – net rental election.
3. Net Rental Election
This essentially is a waiver or an exemption from the withholding tax. By filing the net rental election you pay tax on the net rental income earned at graduated tax rates. That means expenses can be deducted in arriving at the net rental income. Expenses include (continued…….)
mortgage interest, property taxes, utilities like gas, water & hydro, home insurance, management fees, repairs, depreciation, and so forth. To apply for the net rental election, complete form ‘W-8ECI’. This form is referred to as ‘foreign persons claim for exemption from withholding on income effectively connected with the conduct of a US trade or business’. You have to file form W-8ECI with your property manager or management company every three years.
4. 1042-S – Collecting Rent
The fourth point surrounds information return ‘1042-S’. This deals with the amount of rent collected and property taxes paid in a year. This information return reports those two items to the IRS every year and is completed by your property manager or management company.
5. Using a Cross Border Tax Accountant
The fifth thing you need to know about buying US real estate as a Canadian is that you must hire a cross border tax accountant. Navigating through these forms and applications is very complex so you want it done properly by a professional accountant.
Additionally, your cross border tax accountant will prepare your US non-resident rental tax return, form ‘1040-NR’. This tax return reports the amount of net rental income you’ve earned in a year and computes tax at graduated income tax rates. The return is due on June 15th of every year.
I hope you found the 5 things Canadians need to know about buying US real estate useful. If you’re looking for more tips or tricks simply visit my website. You can also get access to my free report 20 Free Tax Secrets from www.madanca.com which can help you save a lot in taxes.
Tuesday, April 12, 2011 9:41 AM EDT
What Canadians Need to Know About Buying U.S. Real Estate
By Jim Adair
A recent survey conducted for BMO Bank of Montreal says that one in five Canadians are interested in buying property in the United States. According to the National Association of Realtors, 23 per cent of international buyers were from Canada last year – making us the largest group of foreign buyers for the past three years.
It’s not hard to understand why Canadians are being drawn to U.S. property. Canadian “snowbirds” have been spending their winters in southern states for years to escape the cold. Housing prices have fallen by 30 per cent during the last four years and the strong Canadian dollar has made buying in the U.S. even more attractive.
Several U.S. developers and investment groups have been pitching Canadians on the benefits of buying U.S. property, but before you jump into the market it’s essential to do your due diligence first. There’s a wide range of tax, insurance, legal and lifestyle issues to consider before making the plunge.
The first big question is why do you want to buy a property in the U.S.? Is it for a second or vacation home, or strictly as an investment?
If you’re a Canadian who doesn’t spend more than 121 days in the U.S. in any tax year, you are not considered a U.S. resident for income tax purposes. However, stay longer and without proper tax planning you risk having to pay income tax in both countries. There may be ways to avoid this but you need to get professional help from people who understand the U.S. tax laws.
If you plan to live in the property part of the year but leave it vacant the rest of the time, you will probably need to hire a property manager to take care of it while you’re away, to avoid burglary and vandalism.
If you’re planning to rent the property out for part or all of the year, the U.S. Internal Revenue Service will consider you a “non-resident alien” and you must pay U.S. income tax on the rental income. There’s a 30 per cent withholding tax on the rent you collect, which must be deducted by you or the property management firm and sent to the IRS.
Accountant Jim Yager, in a contribution to the book Fire Sale by Philip McKernan, says you can avoid this withholding tax by filing a U.S. tax return and paying tax on net rental income, after expenses such as mortgage interest, maintenance, insurance, property management and property taxes have been deducted.
If you sell your U.S. property, there’s a withholding tax of 10 per cent of the gross sale price. Yager says there are two exceptions to this rule: if the sale price is less than $300,000 and the purchaser plans to use the home as a residence; or if a withholding certificate is obtained. This certificate can be issued if the tax liability will be less than 10 per cent of the sale price, and will show what amount should be withheld by the purchaser rather than the full 10 per cent.
Tax issues can get complicated in a hurry, and to make things even murkier, some states have their own income tax regulations in addition to the federal laws.
Property taxes are also a consideration. Some states charge higher property taxes to out-of-state owners.
BMO also says it’s important to be aware of the differences in mortgage financing between the two countries, and to know how interest is charged in the U.S.
“Understand the terms of the property. For instance, is it labeled as short-sale or foreclosure?” says BMO. “The status of the property can have a variety of implications. Be sure to consult with an expert before making any buying decisions.”
Real estate is all about location, and although Canadians have always favoured Florida and Arizona in particular, choosing the right location for your vacation or investment property is critical.
Don’t buy a property without visiting it in person.
Even if you are not planning to live there yourself, it’s important that you determine if it’s a good neighbourhood for your investment dollars. Drive around the area during both day and night. In his Fire Sale book, McKernan includes a list of warnings that your potential purchase may be in a bad neighbourhood. Stay away if property management and good tenants are hard to find. Check to see if resale values are on the decline and look at local crime rates. Do other investors report higher maintenance costs and repair bills than other neighbourhoods? Is there a high rate of tenant turnover and a high vacancy rate?
Insurance is another major consideration. Most Canadians realize that if they travel to the U.S., they require medical insurance. When insuring the property, be aware that some coastal areas that often have hurricanes and flooding will have higher insurance costs. You’ll also want to make your sure have adequate liability insurance. If you’ll be hiring tradespeople to work on your property, make sure they are covered with workers compensation.
For financing options, BMO suggests using a U.S. financial institution that has ties to a Canadian bank. BMO and other major Canadian banks have U.S. subsidiaries. “Staying within the family can save a lot of time and headache,” says Laura Parsons, BMO mortgage specialist. “Alternatively, seek out Canadian banks that are already established in the U.S. and the area you are looking to purchase in.”
THURSDAY, 16 JUNE 2011 09:22
The basic tax concepts that determine taxability are residency/citizenship, and where the work or business activity took place. The business (rental) activity happened in the US, therefore the income is taxable in the US.
Following are five misconceptions Canadians may have about buying US real estate, from Keats, Connelly and Associates’ partner and CEO, Dale Walters, a leading cross-border wealth expert.
1. If I report my rental (or capital gain) income in Canada, I will not have to report the income in the US. Conversely, if I report in the US, I will not have to report in Canada.
Likewise, as a resident of Canada, you are subject to tax on your worldwide income regardless of where it is earned.
You can use the foreign tax credit to reduce your Canadian tax by the amount of the US tax paid, if any.
2. Owning US real estate in my Canadian corporation is a good idea.
There are a number of reasons not to own US real estate in or through your Canadian corporation and for most people, there is no real advantage in doing so.
Any profits will be subject to double tax in the US. You will also lose the special tax treatment of long-term capital gains at the 15 percent rate. All income in a corporation will be taxed at ordinary income tax rates, which range from 15 to 38 percent. Foreign rental income cannot be deferred income in your Canadian corporation.
3. If I rent only to Canadians and they pay only in Canadian dollars, I will not owe US taxes.
This misconception is similar to the first one, but one that is asked quite often. Again, the basis for taxation is fundamentally two things: residency/citizenship and where the activity took place.
Where a tenant is from or what currency they pay you in is irrelevant to the taxability of the income. You must pay tax in the country the income is earned and in the country you live in. Do not forget to use the foreign tax credit to prevent double taxation.
4. Having a house in the US, at my death, will cause all of my assets to be subject to US estate tax.
The nonresident estate tax system is set up to tax only the assets in the US at the time of death. If you do not want to, you do not have to let IRS know about any of your other assets. However, it is usually beneficial to let the IRS know of your worldwide assets because of the exclusion from US estate tax allowed under the US-Canada Treaty.
The US-Canada Treaty allows Canadians to use a percentage of the exclusion Americans are allowed – currently $5,000,000 per person. The exclusion is based on a percentage of assets in the US, compared to your worldwide assets. For example, if that exclusion worked out to 10 percent, you would be allowed a $500,000 exclusion per person. There is one catch however: You have to report to the IRS your worldwide assets.
5. The US will impose a tax of 50 percent on assets subject to US estate tax.
The 50 percent tax is part exaggeration and part lacking information about the US-Canada treaty. Prior to 2010, the highest marginal tax rate was 45 percent; the rate is now a flat 35 percent for amounts over the exemption.
As mentioned above, the Treaty allows Canadians an exemption based on the percentage of US to worldwide assets. As long as your worldwide assets are less than $5,000,000 ($10,000,000) per couple, there will be no US estate tax.