If you are a Canadian citizen and resident and own residential rental property in the US, you are subject to U.S. income tax on any property income you receive from your U.S. real estate property. To comply with this Internal Revenue Service (IRS) tax reporting requirement, you may choose one of the following two methods to report the U.S. rental income:
METHOD #1: 30% Withholding Tax on Gross Rents
You can choose to have your gross rental income taxed at a flat 30%, but using this method does not permit you to deduct any expenses from operating your rental property. Most often, this can be a very expensive option. The advantage of this method, is that you do not have to file a U.S. tax return to report this property income. However, you will still need to report the net rental income from your U.S. rental property on your Canadian income tax return. In doing so, it is important to follow Canadian tax rules – even though the property is located in the US. Foreign tax credits can be taken to eliminate duplicate taxation, but depending on your circumstances, it is possible that the full 30% U.S. withholding tax will not be fully recovered. Your withholding agent is required to provide you with Form 1042S, detailing the amount of gross rental income received and the amount of non-resident tax withheld. You must then file Form 1042 with the I.R.S. by March 15th of the following year.
METHOD #2: Net Rental Basis Instead of the Gross Rents method
You can elect to file a U.S. non-resident income tax return (Form 1040-NR) on a net rental income basis and complete Schedule E – Supplemental Income and Loss from real estate rental. Net rental income is defined as gross rents less operating expenses, such as insurance, mortgage interest (not principal), property taxes, repairs, supplies, management fees and utilities to name a few. It must also be noted that, unlike in Canada, U.S. tax laws impose a mandatory deduction for depreciation for U.S. tax filing purposes. For instance, U.S. residential rental property is depreciated on a straight line basis over 27.5 years. If depreciation is not used, as might be the case if there is a rental loss, then it cannot be “banked” for use in future periods. The benefit under method # 2 is that your net rental income property amount, subject to U.S. tax at your marginal tax rate, will likely be substantially lower than the gross rental property income amount subject to the 30% withholding tax. If you elect to file on a net rental basis, then you will need to complete Form W-8ECI to avoid the 30% U.S. withholding tax. You will need a U.S. tax identification number in order to make this election, which can be obtained using Form W-7 ITIN Application for IRS Individual Taxpayer Identification Number. Form W-8ECI is used if the rental income can be demonstrated to be effectively connected income (ECI) to a U.S. Trade or Business, which allows for taxation at graduated rates ranging between 10-35% depending on the amount of taxable income. Foreign persons that own real property in the United States and rent it out may be considered to be engaged in a trade or business if the activities related to their investment are regular, continuous and substantial. Form W-8ECI needs to be submitted to your tenant or to a U.S. agent (not to the IRS).
Notes:
Florida property rentals – for information specific to Canadians owing Florida property rentals – please refer to the article on the Edelkoort Smethurst Schein CPA’s LLP web-site. Click here.
Rental income that is not considered to be effectively connected income (ECI), would be considered to be fixed and determinable annual or periodic (FDAP) income that is not effectively connected with the conduct of a trade or business in the United States. These items of income include but are not limited to interest, dividends, services, rents, royalties, and wages. FDAP is taxed at a fixed rate on a gross basis of 30%.
If the property is “used as a home,” your rental expense deduction is limited. This means your deduction for rental expenses can’t be more than the rent you received. For more about this rule, see IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
If the property is “used as a home” and you rent it out fewer than 15 days per year, you do not have to report the rental income.
If you personally use your property and sometimes rent it to others, special rules apply. You must divide your expenses between the rental use and the personal use. The number of days used for each purpose determines how to divide your costs.
Net Rental Basis — Tax Forms Required and Deadline
If you choose to be taxed based on the net rental basis option, then you will have to file a U.S. tax return and Schedule E by June 15 of the following year even if the net rental calculation results in a rental loss. Bear in mind that to avoid late interest charges with the IRS, any balance of tax owing must be paid to the IRS by April 15 of the following year.
If the June 15 deadline is missed, then there is an additional 16-month grace period to file a return on a net rental basis. Beyond the 16-month grace period, you will no longer be eligible to elect to pay on a net rental basis, and the 30% withholding tax on gross rental income (plus any penalties and interest) will apply for that tax year. For jointly held properties, each party is required to file a separate tax return and report their proportion of the rental property income and expenses.
Depending on the state that the rental property is located, there might be state tax filings that are required as well.
In addition to your U.S. tax filing obligations, you will also need to report on your Canadian tax return in Canadian dollars the net U.S. rental income/loss based on Canadian tax rules. Permanent Canadian residents are taxed on their worldwide income, which would include your U.S. rental property. In most cases, foreign tax credits taken on the Canadian tax return will alleviate duplicate taxation issues.
US Tax laws pertaining to U.S. residential rental properties (as detailed in IRS Publication 527 and elsewhere) are fairly complex. This article provides a broad overview of the U.S. tax laws which Canadians should consider when renting their U.S. residential properties. Individuals should consult with a qualified tax advisor, accountant, legal professional or other professional to discuss implications specific to their situation.
If you require further assistance, please contact our office to schedule an appointment. I don’t mind talking to you for a minute or so as an introduction. If you prefer to have a tax consultation prior to engaging my services, there is a fee for this service. We offer a 1 hour consultation during which time we will provide an in-depth review your situation, and provide specific tax guidance. I would greatly appreciate the consultation fee being paid at the time the meeting via personal cheque, credit / debit card, or e-interact. Thank you very much – I look forward to hearing from you and supporting you with your income tax Canada and U.S. filings.
Contact
Derek Edelkoort, CPA, CGA,
Partner
IRS Registered Paid Tax Preparer and IRS Certified Acceptance Agent
Edelkoort Smethurst Schein Chartered Professional Accountants LLP
4903 Thomas Alton Boulevard, Suite 207
Burlington, Ontario, Canada L7M 0W8
Office: 905-517-2297
Fax: 905-291-0886
Web: es-cpas.com
Disclaimer
This article is about the U.S. and Canadian tax consequences of Canadian residents owning and renting U.S. Rental Properties. Readers are cautioned that information in this article is for general purposes only and does not purport to provide specific advice. Individuals should consult with a tax professional. The author bears no responsibility for the use or dissemination of this information.
Edelkoort Smethurst Schein CPA’s LLP, CGA is registered in public practice with the Chartered Professional Accountants of Ontario to provide personal taxation services to the public, is an authorized Canada Revenue Agency (CRA) e-filer, and is also an Internal Revenue Service (IRS) Registered U.S. Paid income Tax Preparer. Derek Edelkoort is an IRS Certified Acceptance Agent. Geoff Smethurst is a Licensed Public Accountant (LPA) – the firm provides review engagement and audit services.