It’s no secret that Canadians enjoy heading south during the winter to bask in the warmth and sunshine of states like Florida, Arizona, California, the Carolinas and Hawaii. In fact, many Canadians buy their own property in one of these hot locales. Of course, travel down to the States also means spending US dollars. These days (and for a few years now), it’s been costing us Canadians a 30%+ premium to go and spend our hard-earned cash in America.
As a result, the number of Canadians visiting the US has understandably taken a serious hit. US tourism was so low last year that some popular Canadian “snowbird” destinations, like Myrtle Beach, for example, began advertising to Canadians that they would accept our dollars at par with their local currency just to try to boost business. But, for the most part, and for the foreseeable future, travel to the US remains an expensive proposition.
The current environment has stimulated some Canadian owners of US real estate to get out of the US market. In many instances, this has been the case even where the owner did not make a capital gain on the property. Instead, the impetus to sell was driven by the appeal of capitalizing on the strong US dollar.
In 2010, when the Canadian dollar was at par with its American counterpart, the US market saw an influx of Canadian buyers of US real estate. Where the owners of US property bought when the currencies were at par and are now selling when 1 US dollar is equal to 1.3 Canadian dollars, they are earning capital gains on the foreign exchange in addition to any capital gain they may have earned on the actual real estate.
We know that when a Canadian sells US real estate, she is required to file a US tax return to report the gain (or loss) on the sale. (She is also subject to the FIRPTA withholding rules which are not the subject of this article, but can be reviewed here.) The same capital gain (or loss) must be reported back in Canada and any tax paid to the US should be deductible against Canadian tax under the Canada-US Tax Treaty – the Treaty provides for foreign tax credits to be applied against the Canadian tax. Where the currencies in the two countries are different, additional calculations are required to account for the different values.
The Canadian Income Tax Act sets out the rules for calculating a capital gain (or loss) on the sale of capital property that was made in a foreign currency. The application of the rules is best illustrated by example.
In 2010, Susan Snowbird bought a condo in Naples, Florida for $500,000 USD. On the closing date, the Canadian dollar was at par with the US dollar. Susan and her Toronto-based family enjoyed regular visits to Naples every winter for several years. In 2016, Susan decided to sell the condo for $500,000 USD. She planned on converting the proceeds of sale (in US dollars) to Canadian dollars to take advantage of the weak loonie. The exchange rate on the date of the sale was 1 US dollar to 1.3 Canadian dollars.
As Susan sold the condo for the same price at which she bought it six years earlier, it is clear that she did not make a capital gain on the real estate. However, the table below will show that she was able to make a capital gain on the foreign exchange component of the sale.
The table below also reflects the tax rates that Susan is subject to in each country. Given that Susan held the condo for more than one year, it should constitute a capital property for US capital gains tax rate purposes. As such, she should be eligible for the long-term US capital gains tax rate. Assuming Susan is in the highest US federal tax bracket, the top US marginal rate of 20% will apply to the sale. State income tax will not apply as Florida does not levy income tax. Again, assuming Susan is in the highest tax bracket on the Canadian side, she would be subject to the combined federal and Ontario rate of of 26.76%.
|US Capital Gains Tax (USD)||Canadian Capital Gains Tax (CAD)|
|Proceeds of sale||$500,000||$650,000|
|US top federal marginal capital gains tax rate of 20%||nil|
|Canadian combined federal and Ontario capital gains tax rate of 26.76%||$40,140|
|Less Foreign Tax Credit to account for tax already paid to the US. However, since no tax was paid to the US, no foreign tax credit would apply.||nil||nil|
|Net Canadian Income Tax Payable||$40,140|
The table above illustrates that for US reporting purposes there is no gain and no tax owing (although FIRPTA withholding may apply). In Canada, however, Susan reports a capital gain reflecting the $500,000 USD proceeds at the Canadian dollar value multiplied by the exchange rate of 1.3, which equals $650,000 CAD. Since the currencies were at par when Susan purchased the property in 2010, her cost base for Canadian tax purposes is the same as for US purposes, i.e., $500,000 CAD. Since Susan only reported a gain in Canada, she will only pay tax to the Canada Revenue Agency at her marginal rate.
After tax, then, Susan pockets $109,860 CAD from the sale of her Florida condo, solely from the foreign exchange capital gain.
To highlight the difference where a gain is reported in the US, let’s look at another example. In this example, Susan sells the condo for $600,000 USD.
|US Capital Gains Tax (USD)||Canadian Capital Gains Tax (CAD)|
|Proceeds of sale||$600,000||$780,000|
|US top federal marginal capital gains tax rate of 20%||$20,000|
|Canadian combined federal and Ontario capital gains tax rate of 26.76%||$74,928|
|Less Foreign Tax Credit to account for tax already paid to the US. However, since no tax was paid to the US, no foreign tax credit would apply.||($26,000)|
|Net Canadian Income Tax Payable||$48,928|
In this example, Susan realizes a $100,000 USD capital gain and pays 20% tax to the IRS. In Canada, she realizes a much larger gain of $280,000 CAD, after accounting for both the real estate and foreign exchange gain components. Susan is able to apply foreign tax credits to reduce her Canadian tax owing by the amount she has already paid to the US (after converting the US tax paid to the equivalent Canadian dollar amount). Ultimately, Susan pockets about $231,072 CAD.
These examples illustrate a few takeaways. First, when you capitalize on the strong US dollar, you may make a foreign exchange capital gain in Canada – even if there is no capital gain on your property. Fluctuating foreign exchange rates may influence whether or not selling US real estate is lucrative at any given time. Second, remember that the Treaty benefits Canadian sellers of US real property: even when there is a capital gain on real estate on both the US and Canadian sides of the border, the Treaty ensures that tax liabilities owed to Canada are reduced by the amount of tax already paid to the IRS. Selling your US real estate is an important decision regardless of the foreign exchange rate climate – seeking professional cross-border guidance may be beneficial when weighing the tax consequences of making a foreign sale.