Selling Your U.S. Property: Is there U.S. & Canadian Capital Gains Tax?

By Bradley Thompson
May 6, 2020


When a Canadian resident (non-citizen of the US) sells their vacation property in Florida, any capital gain realized is subject to US tax (and withholding) but is also subject to Canadian tax. The US tax rates applicable to “long term capital gain” (gain on capital property owned for more than 12 months) are generally 15% or 20% (there are technically 3 tax brackets on capital gains for this purpose: 0% on capital gains for single taxpayers with taxable income less than $39,376; 15% for single filers with taxable income less than $434,551 and 20% for single filers with taxable income of $434,551 or more). There is no Florida income tax on individuals.

On the Canadian side of the border, for both federal and provincial tax purposes 50% of capital gains are subject to tax at ordinary graduated rates. In the province of Ontario, the highest marginal rate is 53.53% (that bracket is reached for incomes in excess of 220,000). In other words, the entire capital gain (the income recognized from a US perspective) is subject to tax at an effective rate of 26.765%.

Assume a USD$500,000 (CAD$658,000) gain on the sale of a Florida vacation property. Assume also that this is the only US income for the year and that the taxpayer has significant other income in Canada (i.e., she is in the highest marginal tax bracket). In this example we would generally expect approximately USD$72,000 (CAD$95,000) of taxes owing to the Internal Revenue Service and CAD$175,000 owing to Canada Revenue Agency. Under Article XIII of the Canada-US income tax treaty, because the gain relates to the sale of US real estate, the US has primary jurisdiction to tax this income and Canada should generally give a foreign tax credit (FTC) for the US taxes paid. If Canadian taxes are higher than US taxes there would be a balance to pay in Canada.

In this example the IRS would collect approximately USD$72,000 and the Canadian tax authorities would collect approximately CAD$80,000 (CAD$175,000 less CAD$95,000 of US taxes paid). Right?

In practice that is how the Canadian rules grant the FTC in this context. A recent Federal Court of Australia decision (Burton v. Commissioner of Taxation [2019] FCAFC 141), decided under rules similar to Canada’s, casts some doubt on this conclusion.

In this case an Australian resident realized a capital gain on the disposition of real estate located in Pennsylvania. The tax treatment as between the United States and Australia was similar to that as between the United States and Canada. The US taxed the entirety of the gain at favourable rates; Australia taxed 50% of the gain at ordinary rates. The Australian resident claimed a foreign tax credit for the full amount of US taxes paid against his Australian tax liability.

The Australian tax authority disagreed on the basis that the individual’s foreign income was only 50% of the capital gain, and therefore only 50% of the US taxes paid should be creditable in Australia. In a 2-1 decision, the Federal Court of Australia agreed, if convolutedly.

Under the Australia-US tax treaty Article 22(2) provides the treaty mechanic for granting a foreign tax credit. The relevant words parsed by the Australian court were “United States tax paid under the law of the United States … in respect of income derived from sources in the United States” on one hand (the taxes eligible to credit) and “Australian tax payable in respect of the income” on the other hand (the tax against which a credit may be afforded). The basic question was whether “income” meant the 50% inclusion in Australia or the 100% inclusion in the US.

Somewhat surprisingly the majority of the Court concluded that only the US taxes paid on the Australian measure of income (i.e., the US taxes paid on 50% of the gain) are creditable despite the fact that the US taxes the entirety of the gain.

Both the US and Australia have a tax policy of taxing gains at more favourable rates than other income, but arrive at this policy objective through different mechanical rules. The US directly taxes 100% of gains at favourable rates; Australia taxes 50% of gains at ordinary rates, resulting in a favourable effective rate.  The court nevertheless concluded that “it is not double taxation if one jurisdiction seeks to tax more aspects of a singular transaction than the other; it is only double taxation when they both seek to tax the same thing”.

This Australian decision is somewhat disconcerting for Canadians realizing gain on the sale of US real estate. The language in Article XXIV(2) of the Canada-US treaty governing foreign tax credits is similar to the language considered in Burton. In practice Canada Revenue Agency allows a FTC for all of the US taxes paid on a capital gain. This result should be supportable under domestic law (section 126 of the Income Tax Act (Canada)) even if the decision in Burton arguably muddies the treaty interpretation.

Meet Your Legal Team:
Request a Consultation