It’s no surprise many Canadians and Australians moving to the US choose to rent out, rather than sell, their properties back home. With a strong rental market and housing price valuations in cities like Toronto, Vancouver, Sydney and Melbourne, the return on investment from keeping and renting the property can be lucrative.
Unfortunately, becoming a non-resident of Canada or Australia, and conversely becoming a US tax resident, while leaving a rental property behind creates tax filing complexities not only in the US but also in Canada and Australia.
How Do I Report a Foreign Rental Property In the US?
Reporting Income and Expenses
If you own a rental property in Canada or Australia, and you are filing as a U.S. tax resident, the rental income must be reported on Schedule E of your U.S. tax return. For US tax purposes, the allowable expenses you can claim against the rental income are generally the same as in Canada and Australia although under US tax law its mandatory to claim depreciation, even if the property is negatively geared(more on this later).
Adding further complexity is the need to generally translate all your income and expenses from Canadian and Australian dollars to US dollars on the date of each transaction.
On the bright side, you can take a tax credit against your US federal income tax for income taxes paid to Canada and Australia on your net rental income. That credit is limited to the amount of US Federal tax you paid on the rental income on your US tax return. Sadly, for California residents, no tax credit is allowed for income taxes paid to Canada or Australia, essentially resulting in a double tax.
How do I Determine My US Tax Cost Basis?
Determining your US tax cost basis in a foreign rental property can be tricky, especially if it will be difficult to breakout the value of the property between the land and building component. As such, sometimes it may be necessary to hire a surveyor to assist with ascertaining the valuation of the property to comply with US tax law.
Generally, the US tax cost basis subject to depreciation of a foreign rental property is the lower of:
a) Historical cost plus closing costs and improvements; or
b) Fair market value (FMV) on the date the property is placed into service for US tax purposes
For a lot of our Australian and Canadian clients, given the housing booms back home, the FMV of the property is not usually applicable.
Therefore, we are normally left with using the historical cost of the property that needs to be converted into US dollars at the exchange rate in effect at the time the property was purchased.
For those of you thinking of selling the property, beware, because this means the US can tax you on the full gain on the sale of the property, including appreciation of the property that occurred prior to you becoming a US tax resident. Even worse, for Canadians who bought their properties a decade or more ago, the US will also tax you on the foreign currency gain attributed to the increase in the Canadian dollar. We’ll have more to say on the tax consequences of selling your property as a US tax resident later.
Besides adjusting the cost basis for exchange rate purposes, an additional adjustment may need to be made to reduce the property’s cost basis by the US depreciation that would have been allowed under US tax law for all the years prior to a Canadian or Australian becoming a US tax resident.
How Do I Depreciate My Foreign Property?
In our experience, the one mistake we regularly see made on returns for taxpayers with a foreign rental property is the depreciation method used. While US tax law generally allows a US residential rental property to be depreciated over 27.5 years, for foreign properties depreciation is computed using a 40 year straight line method under the Alternative Depreciation System (ADS).
What if My Property Is Negatively Geared?
Under the US tax code, losses from passive activities, such as foreign rental properties, normally cannot be deducted from income. Nevertheless, an exception exists for taxpayers with a modified adjusted gross income below $100,000 that allows up to $25,000 of rental real estate loss to be deducted against ordinary income, such as wages, provided you “actively participate” in the rental activity(basically you are involved in meaningful management decisions regarding the rental property). This exemption is phased out for taxpayers whose modified adjusted gross income exceeds $100,000 and is eliminated entirely when it exceeds $150,000.
What if I Want to Sell My Foreign Property?
Unless you are Boris Johnson, the Mayor of London, there can be a silver lining for most Canadians and Australians who sell their foreign properties after becoming a US tax resident. If the property was used as your personal primary residence for the 2 years during the previous 5 years prior to sale, you may be able to exclude up to $500,000($250,000 if single or married filing separately) of the gain from your US income taxes under the exclusion allowed for sales of personal residences.
How Do I Report My Rental Property As a Non-Resident of Australia/Canada?
If you are lodging as a foreign resident in Australia, then you must still lodge an Australian tax return to report and pay tax on your Australian income from the rental property. You will need to know the value of the land separately from the building structure to calculate depreciation on the building structure (land cannot be depreciated), and work out your capital gain accurately if you sell the property.
The detailed Canadian tax rules for reporting a non-resident owned Canadian rental property is complex and beyond the scope of this article. We’ll be publishing a separate article on this topic in the near future.
In a nutshell, however, a non-resident of Canada with a Canadian rental property will want to annually file the following forms with CRA:
a) NR6 to avoid being subject to a 25% withholding tax on gross, not net, rental income; and
b) Section 216 Return to report rental income and expenses for the property; and
c) NR4 Return/Slip to report the gross rental income and Part XIII withholding tax.
In case you are wondering, you are not able to claim the Section 45(2) election as a non-resident.
While complying with the various tax rules for a Canadian or Australian rental property can be difficult, the Canadian and Australian cross-border tax specialists at Gedeon Law & CPA are available to provide assistance with the tax filing requirements in the US, Canada and Australia.