Beware the Tax Implications of Offloading Your US Real Estate

Selling your US property

The first thing to know about selling a home in the U.S. is that after you sell it, you’re legally obligated to file a tax return with the Internal Revenue Service — even if you sell at a loss. You’ll be required to fill out IRS Form 1040NR, the document used for non-residents. If you’ve owned the property for more than a year, you’ll also need to fill out a Schedule D form, which details capital gains.

U.S. capital gains levies can be severe. Terry Ritchie, vice president and partner at Cardinal Point Capital Management in Calgary, says the maximum capital gains rate in America is currently an eye-watering 37%. You’ll also have to pay the IRS a withholding tax on the gross proceeds of your sale.

“When a non-resident of the U.S. sells property, the IRS makes sure they get their money,” Ritchie says. “So there’s a requirement to withhold tax when the property is sold.”

Ritchie explains that the IRS generally withholds 15% of the gross proceeds, but if those are less than US$1 million, the level of withholding tax would be 10%. If buyers plan on using the property as their primary residence, and the proceeds of the sale are less than US$300,000, then no withholding tax will be required.

Some states, including California and Hawaii, have their own withholding taxes. But most, including snowbird favourites Florida and Arizona, do not.

You’ll also have to pay tax on the proceeds of your sale to Canada, by reconciling it in Canadian dollars and entering it on your tax return.

“Generally, the level of tax we pay in Canada on the profit will be greater than on the U.S. side,” Ritchie says, adding that sellers can help mitigate the tax hit with a foreign tax credit based on the amount paid to the IRS.

Getting a foreign tax credit approved can be a hassle. Ritchie says the Canada Revenue Agency will ask for a copy of an IRS account transcript to show tax was truly paid in the U.S., and you’ll have to present a copy of your U.S. tax return as well.

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Dying and estate taxes

Ritchie says it’s uncommon for Canadians to die while in possession of U.S. property. If a couple owns a property jointly and one of them dies, the remaining partner typically winds up using it less and eventually sells it before dying.

In the rare cases where Canadian residents die while owning a U.S. residence, their heirs or an executor will have to go through the estate tax rigamarole for the IRS.

But most Canadians will not have to pay estate taxes because the IRS provides a rather generous exemption — $11.7 million; double that for a couple. If your worldwide assets total less than $11.7 million, you’re off the hook completely.

Ritchie says lawyers and accountants often charge Canadians “a lot of money” to help them avoid paying estate taxes. But for most of these property owners, it’s a non-issue.

“It’s important to understand the estate planning implications, but it doesn’t come up as often in a practical sense as it would if you were to rent or sell your property,” he says.

Here’s where things can get unpleasant

If you were to die while still holding your U.S. property, and its value is more than $60,000, your executor is still obligated to file a U.S. estate tax return, Form 706NA. It’s not just a box-ticking exercise. Your estate will have to disclose the fair market value of all its worldwide assets as of the date of death.

“You have to take all your clothes off and present yourself to the IRS, fully transparently,” Ritchie says. “If you’ve got a business in Canada, an RRSP, a RRIF, bank accounts, insurance policies — all of that information has to be included and valued for U.S. estate tax purposes — even though the net result of this exercise is going to be zero.”

That’s not all. When you submit an estate tax return, the assets entered into your 706NA are frozen. “It could take a year, if not longer, for the IRS to even look at the estate return and allow for the property to be unfrozen. It’s a pain ... but that’s just the way it works,” Ritchie says.

In Canada, your estate will have to pay a deemed disposition tax, where the property is considered to have been sold at fair market value, adjusted for Canadian dollars, at the time of your death.

“A lot of snowbirds focus on worrying about their U.S. issues when, at the end of the day, it’s Canada that’s going to get them,” Ritchie says.

If you die and leave behind a spouse, the deemed disposition tax can be deferred by transferring the property to your partner. If your spouse then dies while in possession of the property, their estate will eventually have to pay the tax.

And if no estate tax was paid in the U.S., there will be no foreign tax credit available to help lessen the hit.