This article provides an overview of how the 2018 U.S. individual income tax changes impact Canadians with U.S. Rental Properties.
Disclaimer – This article is about the 2018 U.S. individual tax consequences of Canadian individuals with 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.
On December 22, 2017, the U.S. Administration enacted the Tax Cuts and Jobs Act (TCJA), which introduced broad based and sweeping changes to U.S. corporate, and U.S. personal tax changes. It is important to keep in mind that these changes pertain to federal income tax, as administered by the Internal Revenue Service (IRS). Each U.S. state has its own separate income tax regime.
Under U.S. domestic tax law, a non-resident – whether an individual or corporation – is subject to U.S. federal tax if they have income that is “effectively connected with the conduct of a trade or business within the United States”. Effectively Connected Income (ECI) is generally U.S. source business income attributable to a U.S.-based activity that rises to the level of a trade or business (TOB). The threshold for a U.S. TOB is fairly low, as any profit-seeking activity deemed to be considerable, continuous and regular can suffice. ECI includes situations where Canadian individuals own and operate property rentals in the U.S. Also, capital gains or losses earned on the disposition of U.S. real property, including shares of a U.S. real property holding company, are considered effectively connected to the U.S., even if you are not considered to be engaged in a U.S. trade or business (eg/ sale of personal use real property located in the U.S. by an individual).
Canadian individuals with U.S. Rental Properties file Form 1040NR and schedules to the IRS, as well as states, if applicable.
Summary of changes to U.S. Federal Individual income tax as it pertains to Canadians with U.S. Rental Properties. The Tax Cuts and Jobs Act impacts tax years beginning January 1, 2018 and onwards.
Elimination of Personal Exemption
A significant change introduced in the 2018 Tax Cuts and Jobs Act (TCJA), was the elimination of the Personal Exemption of $4,050 for each individual filing a non-resident individual income tax return (1040NR). Prior to 2018, Canadian individuals owning and operating U.S. rental properties would be able to offset up to $4,050 of net rental income, with their Personal Exemption of $4,050. This often eliminated all taxes owed to the IRS, and most states. Beginning with the 2018 tax year, the $4,050 Personal Exemption is eliminated, meaning that some Canadians might owe tax to the IRS, where in prior years they did not.
Any taxed owed and paid to the U.S. can be deducted as a ‘Foreign Tax Credit’ by Canadians on their Canadian individual tax returns. This eliminates duplicate taxes paid on the same income being included in both U.S. and Canadian income tax filings. Foreign tax credits used to reduce taxes in Canada are closely monitored by the Canada Revenue Agency (CRA). The CRA will almost always audit these credits, and to support these tax credits, taxpayers will need to file a U.S. income tax return, and request an IRS Transcript. It is best to discuss and plan this with our firm’s cross-border tax specialists.
Section 199A Deduction
Tax Cuts and Jobs Act introduces a new 20% deduction of taxable income for small business. Section 199A grants owners of a sole proprietorship, rental property, S-Corporation (not applicable for Canadians who are not resident in the U.S.), or partnerships to claim a deduction against ‘qualified business income’ (QBI) earned by the business. QBI includes rental properties.
A qualified trade or business is any trade or business, with two exceptions:
- Specified service trade or business (SSTB), which includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers
- Performing services as an employee
Rental properties qualify as a trade or business, and are not subject to limitations or the exceptions.
The rationale for the Section 199A deduction is to provide a measure of tax relief, so as to align tax rates for flow-through entities, with the much reduced U.S. corporate tax rate of flat 21%.
Section 199A will reduce taxable income for the rental properties, and in some cases the deduction might be more substantial than the $4,050 Personal Exemption that has been eliminated.
Interest Expense on loan
The interest expense associated with mortgages or loans include lines of credit, used by Canadians to purchase rental properties will continue to be deductible, subject to the same limitations on business use and personal use allocations. The Tax Cuts and Jobs Act introduced limitations on the dollar amount of mortgage (maximum $750,000 USD) for properties purchased on or after December 15, 2017, but these restrictions pertain to U.S. citizens or U.S. resident aliens purchasing personal use residences in the U.S.
Capital Gain on sale of rental property
While the determination of applicable U.S. capital gains rates is different under TCJA, with the rate structure tied to taxable income “breakpoints” instead of tax brackets, there is actually no difference in the effect of those changes. Long-term capital gains that were taxed at zero, 15 or 20 percent in 2017 based on taxable income, will be taxed at the same rate for 2018. This would be relevant for capital gains on sale of rental property in 2018 and beyond.
U.S. individual tax on effectively connected income (2018)
The 2018 U.S. tax rates for Canadians filing single individual U.S. income tax returns (1040NR) are:
The 2018 tax brackets for taxable income over 10%, are somewhat lower than the rates in 2017. However, the elimination of the Personal Exemption largely negates this for Canadians with U.S. rental properties. Section 199A deduction will reduce taxable income. The ultimate tax impact will depend on the situation.
Most States have separate individual income tax rates, and these must also be considered.
For additional information pertaining to Canadians purchasing, owning and selling U.S. rental properties, please be sure to read other articles on our web-site which can be quickly accessed using the links below:
The Tax Cuts and Jobs Act enacted significant tax changes to U.S. individual income taxes. For the most part, the elimination of the $4,050 Personal Exemption will have the biggest impact to Canadians owning and operating U.S. rental properties.
TJCA changes to U.S. individual income taxes are temporary, and the majority of tax changes will revert back to where they were in 2017, on December 31, 2025.
We hope you have found this article useful. For more information on this please visit our web-site for other articles, or contact our firm to discuss how Edelkoort, Smethurst, Schein CPAs LLP can assist you with your U.S. and Canadian individual tax planning and filings. We look forward to hearing from you. Thanks for taking the time to read this article, and best wishes.
Derek Edelkoort, CPA, CGA,
IRS registered paid tax preparer and IRS Certified Acceptance Agent
Edelkoort, Smethurst, Schein CPAs LLP