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As the Canadian dollar continues to weaken against its American counterpart, we want to revisit [tax issues for Canadians that are planning to sell personally-owned U.S. real estate]: More and more Canadians seem to be interested in selling their U.S. real estate to “cash-in” on the gains of appreciated property and a stronger currency. Some may be looking to downsize, others to purchase U.S. property in another location, and still others to no longer own U.S. real estate at all.
To do so smartly, Canadians need to be aware of some surprising roadblocks that often slow down potential sales.
Obtaining an Individual Tax Identification Number
Just as the Canada Revenue Agency uses Canadian Social Insurance Numbers (“SINs”) to identify taxpayers, the IRS relies on U.S. Social Security Numbers (“SSNs”) to track individual filings. A Canadian without U.S. citizenship or work authorization is ineligible to obtain a U.S. SSN but will be required to file a U.S. tax return, so he or she needs to obtain a U.S. Individual Tax Identification Number (“ITIN”) as part of any sale of U.S. property. (Though U.S. SSNs and Canadian SINs are the same number of digits, filing a U.S. return using a Canadian SIN will result in the return being rejected by the IRS.)
The complications of applying for an ITIN often surprise many Canadians who have never had to previously interact with the IRS. In order to obtain an ITIN, a non-U.S. individual must prove both identity and non-U.S. status. To do so, he or she can either mail a completed Form W-7 to the IRS or meet with an IRS “Certifying Acceptance Agent” or an IRS official at an in-person appointment in the United States.
In order to help combat identity theft and fraud, the IRS will only accept (1) an original passport, (2) a certified passport copy issued by Service Canada (not a photocopy certified by a Canadian lawyer), or (3) a passport copy certified by an Certifying Acceptance Agent, an individual who has undergone IRS training and entered into an agreement with the IRS that allows him or her to certify original documents on its behalf.
ITIN applications can also only be submitted with appropriate paperwork: either a U.S. tax return or documents that prove eligibility for specified exceptions enumerated by the IRS.
FIRPTA federal withholding tax
A Canadian seller of U.S. property will also need to address the withholding obligations under the Foreign Investment in Real Property Tax Act (FIRPTA), which authorizes the IRS to tax non-U.S. persons on their sales or dispositions of U.S. real property. Under FIRPTA, the buyer is the withholding agent and is required to withhold and remit the tax at the time of sale.
If a Canadian sells U.S. property, the purchaser (regardless of whether he or she himself is American or not) is generally required to withhold from the sales proceeds and pay over to the IRS on Forms 8288 and 8288-A an amount equal to 15% of the gross (not net) sales proceeds within 20 days of the sale.
Such a system is not unique to the United States – Canada also requires withholding on sales of Canadian property by non-residents pursuant to section 116 of the Canadian Income Tax Act – but what is somewhat unusual about FIRPTA is that the withheld amount often is much greater than the actual tax liability. Canadians who sell U.S. real estate are taxed at the same rates as Americans – by the U.S. federal government at rates of up to 20% on the gain in any property sold after being held a year or longer – but FIRPTA can create significant cash flow challenges.
Indeed, even if a Canadian sells his or her U.S. property for a loss the same withholding applies and – absent a withholding waiver – the IRS will not issue a refund until the taxpayer files a U.S. non-resident tax return the following year. In practice, the withholding is remitted by the escrow company to the IRS, though it is technically the buyers who remain liable for any non-remitted amounts, so it is unusual for FIRPTA not to be enforced.
In cases where the sale is for less than $300,000 USD and the buyer agrees to certify that he or she plans to use the property as a principal residence for at least the next two years (50% of the days in each year), the withholding is reduced to zero. Withholding at 10% is possible when the buyer certifies that he or she plans to use the property as a principal residence and the sale price is between $300,000 and $1 million USD.
The seller may also obtain a waiver from the IRS without buyer certification. To do so, he or she must certify both that withholding was done correctly at the time of acquisition and that U.S. tax returns were filed if the property was rented out. The seller’s history with the property thus becomes important, and previously unknown tax issues may surface when it comes time to sell and potentially apply for a FIRPTA waiver.
For example, changing title on a U.S. property can be done relatively easily at the local county recorder’s office, but doing so without good tax advice can have disastrous tax consequences. If, for example, Canadian parents buy a U.S. vacation home and then later change title to add their children so that the property will pass outside of U.S. probate proceedings, they’ve made a gift of U.S. property. Despite the fact that no withholding is required under FIRPTA in such cases, gifts of U.S. property by non-U.S. persons are taxable at 40% of the value of the property at the time of transfer, with no relief available under the Canada-United States tax treaty. There would also be Canadian tax consequences as a result of doing such a title change that would need to be considered.
Timing complications also often arise with sellers obtaining waivers from the IRS due to the quick turnaround time of the 20-day rule with filing Form 8288. It is not possible to apply for a FIRPTA waiver until a seller has a signed contract with a buyer and, since most U.S. real estate sales have a 30 day closing period while the IRS is allowed 3 months to process a waiver application, it is rare to have a FIRPTA withholding certificate issued by the IRS by the time of closing.
Unlike in Canada, where real estate transactions are generally handled by a lawyer, in the United States it is much more common for parties to use an escrow company – a neutral third party that handles funds for both the buyer and seller and records the ownership change in the local land titles system when the sale closes. Unfortunately, a common misconception among escrow companies is that FIRPTA withholding must be remitted to the IRS within 20 days of closing, which is not true if the seller presents evidence that he or she has applied to the IRS for a FIRPTA waiver before the transaction closed. In such cases, the 20-day deadline is 20 days from the date the IRS responds to the request, not the date of closing.
Nonetheless, many escrow companies will insist on sending funds to the IRS, which can result in an additional several months delay in obtaining an early refund.
Considering that FIRPTA waivers applied for by a seller typically take about 3 months to receive approval from the IRS, the point in the year at which a seller applies for a waiver is also an important consideration. If an individual applies for a waiver in December, it’s likely that he or she may receive the refund just as quickly by filing the 1040NR (individual income tax return for non-residents), which is required in any case. By contrast, for a January sale, a waiver may prove more valuable since the alternative will be for the Canadian seller to wait a minimum of 12 months to file a U.S. return to apply for any refund owing.
Withholding issues related to selling U.S. real property are also present at the state level. All states with a state income tax will require out-of-state sellers to file a tax return if they have a gain from a real estate sale and, depending on the state, an individual may also need file a state return even selling at a loss.
Several states – namely California, Hawaii, and Colorado – impose their own withholding on out-of-state sellers on top of the federal FIRPTA withholding that applies to all non-U.S. sellers. For example, a non-resident of Hawaii who owns real property within the state is subject to withholding under the Hawaii Real Property Tax Act (HARPTA), which amounts to 7.25% of the gross sales price of the home.
Additionally, the Hawaii Department of Tax will not accept a HARPTA waiver application within 10 days of a closing for a sale of property so timing can often be tight. California and Colorado have similar laws, where the buyer of in-state property from an out-of-state seller is required to withhold 3⅓% or 2%, respectively, from what would otherwise be paid to the seller. As under FIRPTA, residents and non-residents are ultimately taxed at the same rate on the gain in their properties, but non-residents may nonetheless face withholding that residents do not.
One common problem we often run into on cross-border real estate sales has nothing to do with tax, but it can nonetheless result in delayed or even cancelled sales. Certain U.S. states – including California, Hawaii, Colorado, and Utah – will not accept notarization of documents by a Canadian notary without “authentication” by a U.S. embassy or consulate. U.S. notaries are not allowed to notarize outside the United States, so if a Canadian resident is trying to get a transaction accomplished without having to travel back to the United States or to the nearest U.S. embassy or consulate, this can prove difficult.
In our experience, this is not a problem for sales of property located in Arizona, Florida, Nevada, or New York, where the state governments will accept Canadian notarizations without requiring U.S. government authentication. But we have seen several California and Hawaii sales delayed weeks or cancelled simply because of notarization problems. If a Canadian resident is selling U.S. real property located in a state that does not accept Canadian notarization without U.S. diplomatic authentication, the seller’s options are to either:
- Go to a Canadian notary who is registered with the U.S. embassy or consulate, have him or her notarize on behalf of the U.S. government, and then have that notary obtain the required authentication document from the embassy or consulate; or
- Make an appointment to go to the embassy or consulate and sign in front of a U.S. government official.
Evidently this can prove a large inconvenience for individuals who do not live in or near the seven Canadian cities where the United States operates full diplomatic missions (Vancouver, Calgary, Toronto, Ottawa, Montréal, Quebec City, and Halifax). Our firm has Calgary-based Canadian notaries who are registered with the U.S. Consulate in Calgary and who are able to notarize on its behalf but, evidently, for Canadians living in places like Kelowna or Winnipeg, the notarization required to close a sale can prove challenging.
Notwithstanding the complications or other issues associated with a U.S. real estate sale, it is important to have an experienced cross-border tax advisor to help facilitate a smooth sale of your U.S. property, ensure proper compliance, and manage the tax issues as much as possible.
Moodys Gartner Tax Law is only about tax. It is not an add-on service, it is our singular focus. Our Canadian and U.S. lawyers and Chartered Accountants work together to develop effective tax strategies that get results, for individuals and corporate clients with interests in Canada, the U.S. or both. Our strengths lie in Canadian and U.S. cross-border tax advisory services, estate planning, and tax litigation/dispute resolution. We identify areas of risk and opportunity, and create plans that yield the right balance of protection, optimization and compliance for each of our clients’ special circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Copyright © 2020, Mr. Gabriel Castillo JD, LLM, Moodys Tax Law LLP, Calgary, Canada.