Own Rental Property in the U.S.?
What are Your Tax Liabilities as a Nonresident?
Owning a property and generating rental income is one of the most prudent ways to build an asset, and make it pay for itself. Many Canadians choose this route for securing their long-term finances. In fact, Canadian snowbirds who seek warm, tropical climates to escape the long, harsh winters often invest in cross-border properties in the United States. Similarly, those who find domestic property markets, such as Toronto, Montreal or Vancouver to be too skewed on prices prefer to use their purchasing power for rental properties in the United States.
Vacation rentals make for an excellent revenue stream to cover many other expenses. However, renting out your U.S. property comes with several important considerations, including liability protection, tax implications, and legal / immigration matters that require the support of qualified professionals. Any failure or delays in addressing such matters could lead to huge financial burdens, including potential double taxation or cash flow implications, and unnecessary legal hassles. If you own or plan to buy a rental property in the United States, read on to learn more about effective management of your cross-border tax exposure as a U.S. nonresident.
Rental Income and Tax Planning for Canadians with Properties in the United States
Whether you are a Canadian snowbird who spends several warmer months at your property in the United States, or you simply own and rent out your U.S. property all year round, here are some of the tax planning aspects to consider:
- Canadian residents are subject to a nonresident withholding tax of 30 percent of the gross rental income from their U.S. properties. Your tenant or property manager should generally remit this amount to the Internal Revenue Service (IRS) and issue IRS Form 1042 and 1042-S. With proper withholding, you should not be required to file a U.S. tax return. Read on, however, to ensure that you are not losing out on paying tax on a net income basis.
- Let’s assume, you received $42,000 in rental income, but your expenses were $40,000. Although you did not make much money (only $2,000), if you did not do anything, you would end up with $12,600 tax withheld and $52,600 total loss. Not a great result. So, what can you do?
- Note that you can claim a foreign tax credit on your Canadian tax return and avoid double taxation. As such, the ultimate tax impact for you may not be as dramatic. However, you would want to make sure that you have sufficient taxable income on your Canadian tax return to offset U.S. tax withheld.
- You can make a so-called net rental income election to be taxed on a net income basis. Making this election would allow you to deduct certain expenses related to earning the rental income. In that case, your rental income would not be subject to a 30 percent withholding. Instead, your net income would be subject to tax at applicable graduated tax rates. To make this election and benefit from this common tax strategy, you need to:
- Complete form W-8ECI and provide it to your tenant or property manager; and
- File a U.S. tax return as a nonresident (Form 1040NR, U.S. Nonresident Alien Income Tax Return) to report your income from rental activities in the United States on Schedule E.
- How does this work?
- Let’s assume the same facts as in the previous scenario. Having made the net rental income election, your U.S. tax liability would be zero. Obviously, you would still report the rental income on your Canadian tax return, but there would be no double taxation potentially resulting from no or low taxable income in Canada.
- If you rent your U.S. property for less than 15 days during the calendar year, you may be eligible for tax exemption on the rental income.
- The ownership structure you choose for your U.S. real property may have an impact on several areas of your life, including the guardianship proceedings, liability protection, taxes, and probate. Consulting an experienced cross-border U.S. tax lawyer before buying the U.S. real property will help you make tax-efficient decisions, including allow you to consider various, at times conflicting, income tax, reporting and filing requirement-related, and estate tax objectives.
- If your U.S. rental property is in your personal name and you do not have a U.S. Individual Taxpayer Identification Number (ITIN), you would be required to apply for one by filing IRS Form W-7 with the IRS, before you can file Form 1040NR.
- From both the tax residency perspective and U.S. immigration law standpoint, you need to carefully track all the time you are physically present in the United States.
- If you meet the substantial presence test for U.S. federal income tax purposes, you may benefit by filing with the IRS Form 8840, Closer Connection Exception Statement for Aliens and still be treated as a U.S. nonresident. Contrary to a common misconception, Form 8840 can be filed on its own (provided, of course, you do not have any U.S. source income subject to reporting). Otherwise, Form 8840 is attached to one’s U.S. tax return (Form 1040NR).
Remember, these are only a handful of the generic tax planning considerations applicable to nonresidents owning a rental property in the United States. For example, you may be required to file a tax return in the state where your U.S. real estate property is located (some states do not have individual income taxes and no reporting may therefore be required in those states).
As a Canadian resident, you also need to report your U.S. income to the Canada Revenue Agency (CRA). The good news is that in most cases, you would be able to claim a foreign tax credit for the state and federal income taxes that you pay in the United States and avoid double taxation. But your ability to claim foreign tax credit may depend on the U.S. real estate investment structure you may have and the extent of your taxable income in Canada, as discussed earlier in this note.
Professional Consulting for U.S. Cross-Border Tax Planning
Whether you have already purchased a rental property in the United States or you are evaluating your options and exploring applicable cross-border tax implications, our knowledgeable team can help. The best place to start is to schedule an initial consultation. During the in-depth consultation, we will review your facts and applicable limitations, discuss the applicable legal framework, address all your queries about U.S. rental income and cross-border tax planning and compliance for properties in the United States, and provide you our recommendations on what the best course of action in your case could be.
Need help in cross-border tax filing, compliance matters or any other tax planning services related to your rental income in the United States? Call us at 905-338-9100 or contact us online to book a consultation.