For my first blog entry, I have decided to whet your appetite with an excerpt from my book, Owning U.S. Property- The Canadian Way. Here’s the first half of one of my favorite chapters – Chapter 10: Selling Your U.S. Vacation Home
Chapter 10: Selling Your U.S. Vacation Home
The examples in the following text are based on taxation figures from previous years and may not reflect the most current tax requirements.
Reducing the U.S. Capital Gain Tax
So, you’re selling your condo in Boca Raton, Florida. You paid $500,000 and the sale price is $1 million… Nice work!
IRS Withholding under FIRPTA
FIRPTA stands for Foreign Investment in Real Property Tax Act which is the U.S. federal law that states that, under section 1445 IRC, 10% of the gross sales price of the sale of real estate by a non-resident of the U.S. must be withheld by the closing agent on behalf of the buyer and remitted to the Internal Revenue Service. In our above example that would be $100,000.
This is NOT a tax; it is simply a withholding whereby the IRS will apply it against the tax payable on the capital gain. In this case, the capital gain is the difference between the sale price of $1 million and the initial purchase price of $500,000.
The U.S. Capital Gain Tax Rate
If you own your U.S. property in a Canadian corporation, or even in a Florida corporation, the IRS will tax the gain at approximately 34%. Additionally, there may be State tax as well. In Florida, the Department of Revenue will tax the gain at approximately 5.5%. That totals roughly 40% tax rate on the gain, or $200,000 of tax.
However, if you have the property in the Cross-Border TrustSM (which we discussed earlier) or in your individual name for more than 12 months, you benefit from the IRS capital gain tax rate of approximately 15% on the net gain. In that case, there is no Florida Department of Revenue tax on trusts or individuals!
Reducing the Gain
Let’s see how we can reduce the amount of the gain.Your initial purchase price of $500,000 is known as your cost basis. It can be adjusted upward by the amount of renovations, special assessments of your condominium association and/or homeowners association, and your closing costs and legal fees upon your initial purchase. Let’s say that amount equals $100,000. Now you have an adjusted cost basis (known as the ACB) of $600,000. Now, let’s look at your gross sales price of $1 million to see whether we can reduce it. Deductions include broker’s commission, closing costs, and your attorney’s fees. Let’s say that equals $50,000. Therefore the net gain is $350,000. That leaves you with a U.S. capital gain tax of $52,500 U.S. depending on how you hold title.
How to Get Back the 10% Withholding
In the above case, the seller’s attorney was obligated to remit the 10% withholding of $100,000 to the IRS with Form 8288, although the net capital gain tax is only $52,500. Accordingly, the seller is entitled to the difference of $47,500 by filing a U.S. Income Tax Form 1040NR together with a duly completed W-7 Form requesting a ITIN number. This is a somewhat complicated package of documentation to be sent to the IRS office at Cincinnati, OH USA, 45999.
Generally speaking, the tax return should be filed in January or February of the year after the sale. If you are an eager beaver and want to have it filed right after the sale, the IRS may actually refuse to review it and may actually mail it back to you with a letter stating that they are not reviewing 2009 Income Tax Returns until the beginning of 2010.
Avoiding the 10% Withholding
There is an exception to the 10% withholding rule where the gross sales price is less than $300,000 and the buyer signs a special affidavit attesting to the fact that he/she intends to use the subject property over the next two years for personal use at least 50% of the time that it is in use. BUT be careful with this exception! Firstly, if the price is over $300,000, the 10% must be remitted unless there is adequate time to file an application for a Withholding Certificate prior to the closing where there is little or no capital gain. Or, it could be filed concurrently with the closing and then the 10% maybe retained in the trust account of the closing attorney until the tax clearance certificate is provided by the IRS.
Secondly, the buyer is not obligated to sign the affidavit. If they are unsure of their future intention or plan to rent out the condo they have the right to refuse to sign. Sometimes this takes a bit of delicate explaining to the buyer.
Check back in for my next blog entry where I will post the second half the chapter. The topics that will be covered are:
- Declaring the Gain to Canada Revenue Agency
- Is there a credit in Canada for the U.S. tax paid?
- Can you defer U.S. capital gains tax?
- U.S. Capital gain exemptions of principal residence.
Purchase Owning U.S. Property the Canadian Way, Third Edition either in print or as an eBook directly from our website!