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.