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If you’re not an accountant, capital gains taxation and attribution rules can be tricky, but they have significant consequences for expats in Canada. In fact, the sky-high real estate prices in Toronto and Vancouver have and could continue to cause US expats to owe US tax in certain situations. So, for any expats living in Canada, read our guide below before determining when and if you should sell your Canadian property.
American citizens living in Canada face some unique challenges when they sell their principal residence, and a big part of it is the different ways the countries treat capital gains tax. Under Canadian tax law, the sale of a principal residence is generally exempt from taxation for Canadian residents. If the property has been used as a principal residence for all years of ownership, the capital gain will be totally exempt from Canadian taxation. That’s why it’s important to understand capital gains tax, Canada versus the US requirements.
In general, attribution rules in Canada prevent taxpayers from avoiding tax liability by shifting income sources to family members, such as a low-income spouse or child. If, for instance, an individual transfers real estate to a spouse, and the spouse then sells the property for a profit, the original owner will be taxed for the capital gain—not the spouse.
Unlike in Canada, US taxpayers are not exempt from capital gains tax on principal residences. Instead, Internal Revenue Code section 121 allows a taxpayer to exclude up to $250,000 ($500,000 for certain taxpayers who file a joint return) of the gain from the sale of property owned and used as a principal residence for at least two of the five years before the sale. A taxpayer can claim the full exclusion only once every two years.
Americans living in Canada would pay US capital gains taxes on the entire amount of their house gain above the exemption amount of $250,000 ($500,000 for certain taxpayers who file a joint return). Residents of the prime neighborhoods in Vancouver and Toronto might see that kind of price appreciation in a fairly short period of time. There would not be any Foreign Tax Credit claim to set off the US income tax on this capital gain as this capital gain transaction (sale of principal residence) is completely tax-free in Canada.
US taxes may also arise when the Americans in Canada sell their investment property (not the principal residence) for a gain. Under Canadian tax law, individuals need to pay tax only on 50 percent of their capital gain instead of paying tax on 100 percent of the capital gain. It would result in paying taxes in the US as the Canadian taxes paid on the 50% portion of the capital gain is not enough to offset the US taxes on the capital gain.
Keep in mind that, because of the attribution rules in the US and Canada, both spouses in a married couple are considered owners of the property and will be jointly responsible for capital gains taxes.
Many US citizens in Canada don’t even realize that their principal Canadian residence or Canadian real estate property could be subject to US income tax in the above circumstances, but they will be surprised by a significant tax burden come tax season. For even more comprehensive information, download our free guide to buying and selling foreign property.
Greenback’s expat accountants can help you mitigate the tax liability by using every exclusion and deduction available. Get started with Greenback today, so you know you didn’t pay too much in your expat taxes and can learn about Canada capital gains taxes.