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Taxes and US rental properties

If a U.S. property is solely for your personal use, you won’t need to worry about the tax implications of your purchase until you sell it or die. “If it’s strictly for lifestyle purposes, life is good,” says Terry Ritchie, vice president and partner at Cardinal Point Capital Management in Calgary and author of The Canadian Snowbird in America.

But if you’re deriving any income from that U.S.-based property, you need to declare it to both the IRS and the CRA.

US tax implications

Canadian owners of U.S. rental properties must file a tax return with the IRS. That goes for properties turning a profit and those that may have incurred a loss.

“There are some people who believe that, ‘I’m renting the property, but because I didn’t make any money off of it I don’t have to file a tax return,” Ritchie says. “No, no, no, no, no. You have to file a tax return no matter what.”

Come tax season, you’ll need to file a couple of forms to the IRS: form 1040NR, the income tax form used by non-residents, and a Schedule E, where you’ll enter gross rents and any ordinary, reasonable expenses you’ve incurred in the past 12 months.

Ritchie says reasonable expenses can include:

  • Advertising
  • Insurance
  • Management fees
  • Property taxes
  • Mortgage interest paid
  • Maintenance

But that’s not the end of your Schedule E. You also have to include a mandatory depreciation expense, equivalent to the value of your property divided by 27.5. It’s because of the depreciation expense, Ritchie says, that most Canadian owners wind up with losses on their Schedule Es, which often saves them from having to pay any income tax on their rental income.

The deadline to file each year is June 15. You don’t need a special visa or permit to file taxes in the U.S., but you will need to apply for what’s called an “individual taxpayer identification number” (ITIN). That involves filling out a W-7 form with the IRS and having your passport certified.

While it would seem smart to submit your W-7 ahead of time so you can have an ITIN handy before you file your first U.S. tax return, you can’t actually do that. Your completed W-7 has to be submitted when you file your first 1040NR. Once your W-7 is processed, your ITIN will be attached to your tax return. From that point on, you can use your ITIN to file future returns.

If you and your spouse own a U.S. property jointly and file your taxes separately, Ritchie says, each of you will have to file a 1040NR and get your own ITIN.

Canadian tax implications

Now that you’ve done some flips for the IRS, it’s time to perform the same tricks for the CRA. Once you’ve calculated the value of your gross rental income and expenses in Canadian dollars, you’ll be required to file form T-776. Like the Schedule E you filed to the IRS, the T-776 determines whether your rental property generated enough income to be taxable.

“In many cases, Canadian taxpayers who have U.S. property may have a taxable profit here and not there,” Ritchie says.

There is a way to reduce the amount of tax you pay on your rental income in Canada: by obtaining a foreign tax credit. But that option is only available if you’ve actually paid tax in the U.S.

If you have, the CRA will ask for a copy of an IRS account transcript that shows U.S. tax was paid. Ritchie says you’ll also have to present a copy of your U.S. tax return.

Additionally, Canadian taxpayers with foreign assets valued at more than $100,000 need to disclose the value of the assets and the income they earn by filling out a foreign income verification statement, or T-1135.

“If you do not file this form, and the CRA finds out you didn’t file it, they’re going to spank you,” Ritchie says. “There are penalties that are very difficult to remove, so it’s important that this form is filed in a timely manner with your tax return.”

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