I’m an American living in Canada: how will my principal residence be taxed when I die?
This is a common question for cross-border estate planners. The answer: it depends.
First, it is important to understand that Americans who are resident in Canada in the year of their death have tax reporting obligations to both the Canada Revenue Agency (CRA) and the U.S. Internal Revenue Service (IRS). This is because Canada subjects its residents to the full scope of the Canadian tax regime regardless of their citizenship; and, the U.S. subjects its citizens to the full scope of the U.S. tax regime regardless of where they reside. Complicating these dual reporting obligations is the fact that significant differences exist between the Canadian and American regimes with respect to taxes imposed in the year of death. Canada deems an individual to have disposed of their capital property at FMV immediately prior to death. Any realized gains are included in the taxpayer’s income in the year of death. In the U.S. there is no deemed disposition of capital property at death. Instead, the U.S. estate tax regime applies.
Consider this example: Mr. A is a dual citizen of Canada and the U.S. who has lived in Canada his entire life. Mr. A is a widower who lives in his principal residence, located in Toronto, which was purchased in 2005 for CAD$ 300,000 and had an FMV of CAD$ 1,000,000 at the time of Mr. A’s death in 2017. Mr. A. also owned investments valued at CAD$ 3,000,000. Mr. A’s Will leaves his entire estate to his only daughter.
In Canada, section 70(5) of the Income Tax Act (ITA) deems Mr. A to have disposed of his principal residence immediately prior to death for proceeds equal to FMV, i.e. CAD$ 1,000,000. Consequently, Mr. A realizes a capital gain in the year of his death. Fortunately for Mr. A., the gain from the disposition of a taxpayer’s principal residence is sheltered under section 40(2)(b) of the ITA, commonly referred to as the “principal residence exemption”. As a result, Mr. A will pay no capital gains tax in Canada with respect to his principal residence. Mr. A’s estate will still have to pay Ontario Estate Administration Tax on the FMV of the principal residence at the date of Mr. A’s death, which is levied at a rate of roughly 1.5%. Mr. A’s daughter will be deemed to have acquired the residence at a cost equal to FMV immediately before Mr. A’s death, i.e. CAD$ 1,000,000.
In the U.S., the estate tax regime determines how Mr. A’s assets are taxed upon death. Section 2001 of U.S. Internal Revenue Code (the Code) imposes a tax on the transfer of a U.S. citizen’s taxable estate. This tax is commonly referred to as the ‘U.S. estate tax’ and is levied at graduated rates up to 40%. Fortunately for Mr. A., section 2010 of the Code provides a unified credit that allows assets valued at USD$ 5,490,000 (the “exclusion amount”) to pass free of U.S. estate tax. Mr. A’s principal residence is included in his ‘taxable estate’ for U.S. estate tax purposes, but because Mr. A’s taxable estate is valued at CAD$ 4,000,000 (roughly USD$ 2,928,000), which is well below the exclusion amount, the unified credit available under section 2010 of the Code is sufficient to reduce Mr. A’s U.S. estate tax liability to USD$ 0. As a result, Mr. A will pay no U.S. estate tax with respect to his principal residence, or any other assets, upon death. For U.S. tax purposes, Mr. A’s daughter will be deemed to have acquired the residence at a cost equal to FMV at Mr. A’s date of death.
Note that if we change the facts so that Mr. A died leaving a taxable estate that exceeded the exclusion amount of USD $5,490,000, his estate would be liable for U.S. estate tax; however, there would still be no capital gains tax owing to Canada with respect to his principal residence.
The important take-away is that Americans living in Canada need to be cognizant of the differences between the deemed disposition at death under the Canadian ITA and the U.S. estate tax regime that applies upon death pursuant to the Code. They also need to be aware of their tax reporting obligations to both countries.
Thank you for reading.
Updated: May 17, 2017
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice on any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your circumstances.