Selling U.S. Real Estate
by McLean & Partners
This week we hosted a “Selling U.S. Vacation Real Estate” seminar in partnership with Kim Moody (Director, Canadian Tax Advisory) and Roy Berg (U.S. Tax Law, Barrister and Solicitor) from Moodys Gartner Tax Law. Kim and Roy discussed investment returns on selling in this market, tax considerations – including tax ‘traps’ – to be mindful of, and alternative planning options to consider if you’re not certain on selling.
We will be releasing a “Purchasing U.S. Real Estate” whitepaper by Kim Moody and Roy Berg in October, but in the interim, share with you this blog on things to consider before selling U.S. vacation real estate.
Canadians who purchased U.S. vacation property in the past few years may find that now is the ideal time to sell, considering the interplay between rising U.S. real estate prices and the recent devaluation of the Canadian dollar (CDN) relative to the U.S. dollar (USD). It is also possible that Canadian capital gains inclusion and/or tax rates could rise over the next few years, therefore a gain today could be taxed at a lower rate than it would be one, two or three years from now. Before you sell your U.S. vacation property however, consider the following factors:
DECLINE OF THE CANADIAN DOLLAR
If you didn’t borrow significantly to purchase your property, the appreciation of the greenback against the loonie, combined with the appreciation in U.S. real estate, means you will have an even larger gain when the USD sale proceeds are converted into CDN funds.
If you borrowed U.S. dollars to purchase the property, the decline of the CDN dollar will hurt. Although the CDN gain may be significant, the ultimate cash realized on a sale may be less than expected if any USD debt incurred to acquire the property is repaid.
PAYING TAX ON GAINS AND THE FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT
The gain on sale of U.S. real property is U.S. sourced income, therefore the U.S. has the right to tax the gain before Canada does, with the resulting gain and corresponding tax liability being determined in accordance with U.S. income tax legislation. The Foreign Investment in Real Property Tax Act (FIRPTA) may also apply, requiring the purchaser to withhold and remit 10% of the selling proceeds to the IRS for transactions under $1M USD and 15% for transactions over $1M USD.
As a Canadian resident, you are liable for tax on your worldwide income, which includes any gain on the sale of U.S. real property. Accordingly, the CDN equivalent gain will be taxable in Canada (likely as a capital gain) and Canadian federal and provincial income taxes will apply (the Canadian Tax Otherwise Payable). However, in an attempt to avoid double-taxation, Canada has a foreign tax credit (FTC) regime to allow a FTC (or deduction) to be claimed against the Canadian Tax Otherwise Payable.
The sale of U.S. real estate owned by a cross-border trust may result in a gain being realized by the trust for both U.S. and Canadian income tax purposes. The Canadian “attribution rules” may also apply in respect of the gain, so caution must be exercised before any income tax returns are filed.
The rules that apply to Canadian resident individuals, partnerships, or trusts are similar to a Canadian corporation in respect of the calculation of the gains (U.S. and Canada) and the application of FIRPTA. However, the resulting overall tax burden (U.S. and Canada) including potential taxable benefits, significantly impact the after-tax cash flows from the sale of real estate owned by a Canadian corporation.
If you borrowed in US$ to purchase the property at an exchange rate much higher than today, then you may consider refinancing. A capital loss is triggered equal to the difference between the foreign exchange ratio on the original loan and the foreign exchange rate when refinanced.
Sell the property, take the money and run! This is a good consideration if the property is not currently in a cross-border trust, and the titleholders are still alive. This may also be a good consideration if you are interested in purchasing replacement property in the U.S., and in the next purchase you do through a cross-border trust.
BORROW AGAINST THE EQUITY
You may consider borrowing against the built up equity in the property. In doing so the process of cash-out refinancing are tax free until the property is sold. Proceeds may be used to purchase other investments or life insurance. If the loan is non-recourse against the estate, then the outstanding balance at death reduces the value of the U.S estate for estate tax purposes on a dollar-for-dollar basis.