Canadian Taxation of Recreational Properties Owned by US Residents
The following comments are intended to assist US-resident individuals in assessing the Canadian tax consequences associated with acquiring real estate in British Columbia for recreational or personal use. The comments are of a general nature only and are not intended to constitute tax or estate planning advice to any particular purchaser of Canadian real estate. There are additional income and commodity tax issues relate to real estate acquired for use in a business or for rent or lease. These issues are not considered next.
Graduated Minimum Down Payment Rules
Effective February 15, 2016, the minimum down payment for new insured mortgages increased from five per cent to 10 per cent for the portion of the house price above $500,000. The five per cent minimum down payment for properties up to $500,000 remains unchanged.
Finance Minister Bill Morneau announced these changes in December 2015. There had been a buzz around down payment increases for quite some time. And, given the alternative – increases for all high-ratio mortgage borrowers (those with less than a 20 per cent down payment) – this graduated approach will have a much smaller effect on the overall Canadian mortgage market.
These new rules mean that, for properties that cost between $500,000 and $1 million, Canadians seeking an insured mortgage will now need to put more money down – up to an additional 2.5% of the purchase price. In other words, five per cent down will be required on the first $500,000, and 10 per cent on the next $500,000.
On a $750,000 property, for instance, the new rules mean that a borrower would need a 33% larger down payment (compared to down payment rules in place prior to February 15, 2016), or another $12,500. The new rule doesn’t affect properties over $1 million because these don’t qualify for high-ratio mortgage default insurance anyway.
If your down payment is less than 20 per cent of the purchase price of the property, your mortgage must be insured against payment default by a mortgage insurer. There are three mortgage default insurers in Canada: Canada Mortgage and Housing Corporation (CMHC); Genworth Canada; and Canada Guaranty. It is typically your lender who determines which insurer is used.
What Happens when I Acquire Canadian Real Estate?
British Columbia imposes a Property Transfer Tax (PPT) on the purchaser of real property situated in the province. The PTT becomes payable upon application for registration of a taxable transaction at a land title office. The PTT is computed at the rate of 1% on the first $, CDN of the fair market value of the transferred property and 2% of the remaining fair market value. The acquisition of “real property” in British Columbia may also be subject to the 5% Goods and Services Tax (GST). “Real property,” generally, includes land, any permanent structures thereon, a mobile home (but not including travel trailers, motor homes, camping trailers, or other recreational vehicles), and floating homes. Generally, used residential units are exempt from GST. Vacant land will generally be subject to GST regardless of the intended use of land by the purchaser.
US residents will be subject to Canadian income tax on any capital gains realized on the eventual disposition of the property. A purchaser of Canadian real estate should keep appropriate documenation to support he tax cost (adjusted cost base, or ACB) of the property for use in computing any capital gain or loss on the eventual disposition of the property. Any PTT or GST payable in respect of the acquisition will form part of the ACB of the property to the purchaser, as will any legal expenses and/or commissions paid in respect of the acquisition.
It should be noted that, when the vendor of the property is another non-resident of Canada, the purchaser, regardless of his residence, must ensure that specific withholding and compliance requirements are adhered to in order to prevent the purchaser from becoming liable for the vendor’s Canadian tax liability in respect of the sale of the property to the purchaser. This is discussed in greater detail below.
What Happens During the Period of Ownership?
There are no annual income tax compliance or reporting issues related to holding Canadian real estate for recreational or personal use only. However, it is important to retain documentation to support thecost of any capital improvements made to the property, as such amounts may be added to the ACB of the property to reduce a future gain on sale.
If the property is leased to tenants and rent is collected, a withholding tax of 25% of the gross rents is required to e remitted to the Canadian tax department. If a tax return is filed within time limits, expenses such as interest, property taxes and depreciation may be claimed against the gross rents in arriving at net taxable income and tax is payable on the next taxable income and the withholding tax is creditable against the tax payable. Also, if an NR6 election is filed within time limits, the withholding tax may be based on the net available rents collected (gross rents less certain expenses, not including depreciation), instead of the gross rents.
What Happens When I Dispose of Canadian Real Estate?
The disposition of Canadian real estate poses more significant income tax issues to a US resident. Unlike the United States, Canada imposes tax on the basis of residence, not citizenship. However, non-residents of Canada my be subject to income tax on incomes from employment exercised in Canada, incomes from businesses carried on in Canada, and gains realized on disposition of “taxable Canadian properties.” Canada also imposes tax on certain types of passive income (including renting, royalties, and interest) paid by Canadian residents to non-residents of Canada.
A US purchaser of Canadian real estate will eventually be subject to Canadian income tax on the disposition of direct or indirect interests in real estate that are “taxable Canadian property.” Real property or real estate situated in Canada is the most common example of “taxable Canadian property.” Share of Canadian corporations or interests in resident or non-resident partnerships or trusts that derive most of their value from Canadian real estate will also be considered taxable Canadian property. Shares of US corporations deriving greater than 50% of their value from Canadian real estate are also considered to be taxable Canadian property.
Capital gains are subject to a preferred rate of taxation in Canada. A capital gain is determined by deducting from the proceeds of disposition, the taxpayer’s ACB (tax cost) in the property, and any outlays or expenses made or incurred in connection of the sale One-half of the capital gains (referred to as “taxable capital gains”) is included in the calculation of income for Canadian tax purposes. Assuming they had no other income subject to Canadian income tax, US-resident individuals would pay Canadian federal tax on taxable capital gains realized in 2004 at marginal rates ranging from 20.5% (on the portion of taxable capital gains below $30,000) and 43.7% (on the portion of the taxable capital gain exceeding $100,000). At top marginal rate, the effective rate of tax imposed by Canada on the capital gain would be 21.85% (43.7% times 1/2).
With some limitations, US residents should be able to deduct the Canadian income taxes as a credit against their US federal tax liability in respect of the gain realized on sale. The same may not hold true for any state taxes that may be payable by the US individual on the gain, as some states, such as California, do not grant foreign tax credit relief to their residents for the purposes of computing state income taxes.
What Happens If I Gift the Property or Dispose of it to a Non-Arms Length Person?
Where taxable Canadian property is disposed of to any person by way of gift or to a person with whom the non-resident does not deal at arm’s-length, the proceeds of disposition will be considered to be equal to the fair market value of the property.
What Happens If I Die While Holding Canadian Real Estate?
Canada currently does not impose estate taxes. However, capital gains accruing during the lifetime of a taxpayer (including non-residents) are subject to income tax on death. For Canadian income tax purposes, when an individual dies, he is deemed to dispose of all his capital properties for their than fair market values and is required to pay income tax on any capital gains realized. (The above notification rules and advance payment of tax rules for non-residents do not apply to a deemed disposition on the deal of a non-resident.) The executor acting on behalf of the non-resident decedent must file a Canadian income tax return for the year death any pay any Canadian income tax resulting from the deemed dispositions.
The beneficiaries of the deceased’s estate are considered to have acquired the real property at a Canadian tax cost equal to the deceased’s deemed proceeds of disposition.
The Canada-US Income Tax Convention (the treaty) provides some relief from Canadian income tax deceased US residents who leave taxable Canadian property to a surviving spouse or to certain trusts established on death for the benefit of the surviving spouse. The Treaty also provides US citizens credit against their US federal estate tax liability for Canadian income taxes payable in respect of the deemed disposition of taxable Canadian property on death. A US citizen who purchases Canadian recreational property should ensure that his professional advisors review the impact the acquisition might have on his Will and estate plan.