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Wednesday, March 13, 2013

Canadian and US Income Tax (Rental Income)


A number of readers have asked about the relationship between US income taxes and Canadian income taxes, and specifically how to address US rental income on a Canadian tax form. Again, we are not tax professionals and you should seek your own professional advice, but here is what we have done and understand.

First, premises to keep in mind (see previous posts): we hold the properties in US LLPs (one property to an LLP); in the US LLPs file a 1065 return (with attachments) and generate a K1 form showing allocation of profit to each partner, and each partner files a 1040NR reporting the allocated profit as income. While the LLPs introduce an administrative difference (to not using LLPs), the net effect is that rental income ends up being reported and tax paid on individuals' 1040NRs...so from a US taxation result perspective, rental income is personal income and the LLPs are "transparent". I am sure the details can be debated, but that's the net of it.

OK, so what about Canadian Taxes? Well, the general idea is that US personal income is reported to both the US and Canadian Governments independently, and tax paid independently. To avoid double taxation, there is a tax treaty between the two countries that allows tax paid to the foreign (US in this case) government to be recovered on the individual's home (Canada in this case) tax form. The mechanism is a "Foreign Tax Credit". Of course, the "general idea" doesn't always work perfectly, and there are cases where you don't actually get the money back through the FTC. But let's assume the general case when the FTC works.

The rental income must be reported on the individual's Canadian personal tax form, and there seems to be a few ways that it can be done. I haven't been able to get anyone to say "This is the correct way to report it...". I have heard "Yes, none of the ways you suggest would be INcorrect." Great.

For the first few years, what we did was report the income from the 3 properties exactly if they were 3 Canadian properties. So, we converted the income and expenses to Canadian dollars, and reported them on T776 forms...Statement of Real Estate Rentals. There were a couple of challenges with this: 1) There is a minor difference between the expense categories recognized by the IRS (US) and the CRA (Canada), so we had to make sure our accounting spreadsheet accommodated both. If I recall correctly the difference was in the breakdown of Maintenance and Repairs: separate on one and combined on the other. 2) There is a different calculation for depreciation. And 3) the Canadian tax software didn't like a US address...so we had to fudge that.

I have been conversing with a few readers who also have looked into this, and a couple of other alternatives came up. (A) Report the income as "Income from a Foreign Partnership"; or (B) just report the income as foreign income.

(A) Reporting the income as "Income from a Foreign Partnership seems to drive the need to issue a T5013 Foreign Partnership Information Return...which otherwise didn't seem be be required. Ugh.

On the other hand, (B) reporting the income simply as foreign income seems quite straight forward. For the latter, it appears we can simply record the income and foreign tax paid on a "Foreign Slip" in TurboTax. TurboTax would then transfer those totals to the line titled "Other income from foreign slips" on the "Other Income, Deductions and Credits" schedule, and then cascade it to Line 130 "Other Income Specify (See attached schedule)" on the T1 General. Very simple, and provides the input to the Foreign Tax Credit at the same time. I like it.

We haven't yet filed our Canadian Taxes this year, but I will try the "foreign income" route to see how it works in practice. This will imply that we are not doing a separate depreciation calculation in Canada because we are just reporting the net income as calculated by the LLPs, but the difference is minor and I believe the Canadian calculation is a bit more aggressive, so I don't expect anyone to be concerned.

A tax professional that I talked to opined that "none of the above is incorrect", but he did caution that changing methods like I am contemplating may throw up a red flag and may cause questions or even an audit. That is certainly possible, but I think we have been as diligent, conservative, and above board as possible so that does not cause me concern.

Again, we are not tax professionals. Just sharing opinions. Your mileage may vary.

Oh yes...I mentioned above that the FTC doesn't always work. In past posts I have hypothesized that one such case is if you hold the LLPs in a Canadian Corporation...so you are paying personal tax in the US and Corporate tax in Canada. As far as I know personal US tax can't be recovered through a FTC against Corporate Canadian Tax. But another "gotcha" that I have heard is that if one of the partners in Canada doesn't have enough income to require tax to be paid, then the FTC doesn't return tax paid in the US...because the FTC is a credit against tax "to be paid" in Canada, and applying the FTC cannot generate a refund. Grrr.

35 comments:

  1. Hey, this is the first article from my web surfing (and believe me, I've spend many hours so far) that address our situation as well. It's amazing how much information out there seems to have nothing to do with what I thought was a common situation. Although, every situation is a bit different...

    My family and I moved overseas for about five years and became Canadian non-residents in a non-tax-treaty country. During our time overseas, we bought two properties in Arizona to take advantage of their distressed real estate market. We have the houses under an Arizona LLC partnership we set up down there and my wife and I are the sole members/partners. We've filed US taxes for a few years now, so we send in an Arizona Form 165 for the LLC partnership (no taxes paid because it's a flow through LLC), and we both send in a 1040NR nonresident alien income tax return to the IRS and a 140NR nonresident income tax return to the Arizona Dept of Revenue (the 1040NR and the 140NR both require potentianl taxes to be paid, as in our case).

    We did this as Canadian non-residents, so we didn't have to declare world income to the CRA and thus we didn't report the US income. Now we are back in Canada, we are filing T1 forms again. I also struggled with how to report the US income. Many blogs and articles discussed many confusing and conflicting things and I came to the realization that there is no clear answer on the correct way, as your article also stated. I did phone CRA's various offices (non-resident, international business, and various audit offices). I basically said, "look, I'm just trying to get it right so I don't get audited". Even then, I couldn't get a straight answer. Although one audit office said to fill out a T776 and just report it as rental income. That's all well and good, but it looks like the most expensive option.

    I like the ideas of using Line 130 and just record the Net Income from the US tax forms. The main reason is depreciation that is used in the US on real estate. There is an automatic procedure to depreciate the house(s), which reduces tax owing (at least while you own the houses). All good, but that's not the case on a T776. I don't want to get down the road where we sell the US houses and then pay a whack of tax there because of the capital gain and then not be able to claim all of it up here.

    I think the underlying important thing is to at least account for the income in some way and allow to be taxed in Canada. That'll make the CRA happy. If they ever audit and decide you should have done it 'this way' instead of 'that way', at least they'll be merciful in that you weren't trying to hide it.

    Comments or other strategies or lesssons learned would be grateful. CJ

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    1. We discussed this offline via email...but my first thoughts for others to view/build on:
      I feel your pain!

      I believe we are on the same page with respect to the ins and outs of the various options. I will offer a couple of builds on what you said in your note.

      1) A concern about the use of LLC's
      2) Depreciation to date

      1) Although you may never be audited/challenged, I have a concern about Canadians using LLCs. I worry about the potential of being double taxed. The mechanism that prevents that is that if you pay tax on rental income or capital gains to the IRS, you can usually claim it back as a Foreign Tax Credit on your Canadian taxes. However, I believe FTCs are only legitimate if the income is of the same type. LLCs are transparent from a tax perspective so in the US you are paying personal tax on your 1040NRs. The concern is whether the CRA would see the LLCs as personal or corporate income. Canada doesn't have LLCs and therefore if they wanted to be difficult they might say it is corporate income from a Canadian perspective and disallow the FTCs. Don't know if they would, but I am guessing they "could". That is why we use AZ LLPs in the US instead of LLCs. Canada does know what a partnership is and there is no doubt (I believe) that it is personal tax.

      2) if you had the houses for a few years before you moved to Canada, then you took depreciation during that time. If I were in your shoes I would want to establish a cost basis for the houses as at the day you moved to Canada so you don't pay Capital Gains on the gain prior to that date in Canada.

      So...if you buy into both of those notions, a possibility would be to move the houses to LLPs as of now and establish the new cost basis via that transaction. I haven't thought that through entirely and you would want to do diligence on it. I.e. would that be a deemed disposition in the US? If it was, would it be a bad time to take the pill on appreciation to date? How would the FTC work in that case? Would you recover all of the US tax on the gain against other tax being paid in Canada in the year you did it? Yada.

      If you aren't worried about the LLC thing, on the basis that you are being fair and above board and surely the CRA wouldn't take advantage of you...then I am sure there are easier ways to establish a documented value for the properties as of your move date. Hey. The properties probably gained 20% in the last year!

      In all of this, I would suggest considering the currency rates with respect to timing of the transactions as well. I.e. the Canadian dollar has gone from 80 cents to just over a dollar from 2009 to 2012, and is now back to 97 or 98 cents.

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  2. The T5013 applies only to Canadian partnerships or foreign partnerships doing business in Canada. A US LLP doing business only in the US would not file a T5013.

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    1. Not disputing your conclusion at all...but what facts/evidence leads you there?

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  3. I also liked the Foreign Slips idea, however 2012 was my first year of property ownership in the USA (through an LLLP) so I had a loss. Using the Foreign Income Slip entry page, TurboTax wouldn't let me enter this loss as a negative number on line 130.

    If I want to use the foreign slips approach, how do I enter a foreign loss from rental property from a USA LLLP?

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    1. Hi, I was in a similar situation (except i do not have an LLLP) and I sent to CRA a reassessment of 2010 and 2011 and to my surprise they took the losses as " capital loss" and they adjusted the Schedule E. That took me by surprise. In 2013 I have to declare a gain and if I will follow their approach In Turbo Tax I will have to select "Foreign - Income from outside of Canada" and here the confusion start:
      - if i enter the amount as capital gain i have to fill in "Foreign capital gains/losses", but that will bring 50% of them under canadian tax what is strange;
      - if i enter the amount as "Other foreign income", I assume that later I have to claim the Foreign Tax Credit.

      Indeed a very confusing subject and puzzle that CRA does not look into to provide clear guidance. Even in theyr webpage there are no clear instructions.

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  4. I can't claim any experience with that. We had a few years of low enough net income that no US tax was owing, but we did not have an outright loss.

    My guess is that you can declare a loss in the US, but probably can't carry the loss into Canada to offset other tax due. But I really don't know for sure. Maybe you can offset future gains in the US with this loss, and pay less future tax?

    If you get to the bottom of it, please post the answer here for other readers. Thanks!

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  5. How is a US individual to record rental income in Canadian funds.

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    1. There is quite a bit of detail in the post above about how we filled out our taxes. Bottom line is that renters pay in US dollars, the income is reported in US dollars on US tax forms, and numbers are converted to Canadian dollars before being recorded on Canadian
      tax forms.

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  6. I have a rental property in Florida under an Wyoming based LLP, this is my first year to file US tax. Is there any tax software of online tax filing tools to do my 2013 US tax? Or it is better to fill out the paper forms?

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    1. I use H&R Block Home Premium and Business (the two are bundled together and I just use the Business part) to do the LLP's tax forms. That includes the 1065 and all the supporting forms. The output of that is (a) a tax form to file for the LLP, and (b) K1 forms that provide input to the individual Partners' personal tax forms.
      As "Non Resident Aliens" aka "foreigners" aka Canadians, as individuals we need to file 1040NR returns for our individual income tax. For that I have not found any consumer oriented software. There are many solutions for 1040's, the forms that Americans file, but none that I found for 1040NRs. So, for those I just download fillable PDFs from the IRS site and fill them in manually. They are pretty simple anyway.
      I would be happy to hear from anyone who has a better solution.
      See previous posts about tax software. The net of it is that I don't like the user interface of the H&R block software, but the main competitor doesn't do the full job.

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    2. Thanks for the information. In my case, the rental house is in Florida and LLP in Wyoming, I need to file Federal tax as 1065 and K1, do I also need to file state tax?

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    3. I am not knowledgable about Florida or Wyoming. If the house was in Arizona as ours are, then my understanding is that you would need to file a state equivalent of the 1065 (AZ165 I believe) with the State on behalf if the LLP, although thee is a clip level below which it is not required. I believe that is true no matter where your LLP is registered. I stand to be corrected though if anyone has better information. In our case our LLPs are registered in Arizona which is also where the properties are.

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  7. Hi Everyone,
    From all the discussions I did not get the essence. What form do we file our US income- T776 or Federal Foreign Tax Credits. What would be the exchange rate in CAD? ( Bank of Canada's Exchange rate as of Dec 31,2013?? maybe?) and if we don't file profit and therefore no taxes to pay , is there any difference of filing to CRA?And te reverse - we file loss in 1040NR, what we file and when????

    ReplyDelete
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    1. We are now using the Foreign income method...see above...but note that our properties are held in US LLPs. That method might not be applicable if properties are held in your own name.
      Exchange rate averages by year are posted on the Bank of Canada web site.

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  8. I purchased a property in my name in Memphis. This is my first year of tax filing. Only One month rent was received in 2013. I want to know which exchange rate to be used. Monthly rate or yearly? What step I need to take for US Tax obligation. Thanks in advance for any feedback.

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    1. Income would need to be reported to both the US and Canadian governments. If the property is personally held and you are a "non resident alien" per US tax criteria, then it believe you would report the income to the US government on a 1040NR (with appropriate schedules) return. On the appropriate schedule you would report income and expenses to arrive at taxable income. If that's your only US income likely you wouldn't owe tax. However if you do pay tax in the US then you claim it back as a Foreign Tax Credit against tax paid on similar income in Canada. You would also declare the income on your Canadian tax forms...T776 if I remember right.

      Exchange rates can be found on the Bank of Canada site. Both monthly and annual rates are listed. If I just had income in December I would probably use the monthly rate, but in the normal case where income and expenses are spread through the year I use annual averages.

      This is a pretty general answer/opinion for a general question. I am not a tax expert and your situation may have complexity I am not aware of so it is a good idea to talk to a tax expert at least to get going.

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  9. why not take it to some tax professional - like H & R block that has experts in doing 'cross boarder taxes' and spends a lot of time and effort training these people -- then the next year you can follow their lead and just keep it consistent???

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  10. My rental vacation house is in Florida, it is owned by a US LLP, and I am Canadian and I am the partner of this LLP. I asked an accountant to help me to file my first year return for 2013, she filed Form 1065 and Schedule K1. I asked her if I need to file 1040NR, she said no because I am a company, I do not need 1040NR. Last week I received a letter from IRS, says my return is not completed, I need to file Form 8804 for withholding tax related stuffs. I asked my accountant, she has no idea about it. I believe she is not experienced in foreign partnership. Anyway, my question is how you guys deal with the withholding tax for Canadian partnership.

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    1. You may find value in looking back through older posts here where I have described how we file taxes. At a very high level, I believe your accountant is incorrect. If your LLP generated income (as shown on the K1 forms) those K1s become input to your 1040NR individual returns. Think of a K1 as a T3 or T5 in Canada...they are inputs to your individual tax return.

      Withholding related forms (there is at least one post on those too) are for making instalments towards next year tax due. The letter you received is probably a generic form letter the IRS sends to everyone with an LLP telling you of your obligation to do withholdings. Even for very small LLPs there is a requirement to do those withholdings. I am not sure if the IRS would come after you for not doing the withholdings if they receive your return and any payment due at the end of the year or not...but they do require proactive submissions.

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    2. You need to file the partner return in the US, and if all your partners are Canadian, you are expected to file the Canadian partnership return as well. (We avoid this by having a 1% US partner). You each also file the 1040NR return in the US and also personal return in Canada. All will need to apply for an ITIN (tax ID number in US) as well.

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  11. Should I use the annual average exchange rate to convert my us rental income/expenses on my cdn tax return? Do I do this for each individual line item or just the totals? Thanks for your help with this.

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    1. We hold our properties in LLPs and as described we calculate the profit in the US and just report the final number as "other foreign income" on our Canadian return...so we just use the average annual currency conversion factor published by the bank of Canada to convert that single number.

      If instead we were calculating the profit in Canada and therefore reporting all the revenue and expense line items on our Canadian return, we would have to convert each line tiem. Again we would normally apply the average annual conversion factor.

      I suppose that if we had a special circumstance such as the initial purchase that dwarfed the rest of the transactions in size, and it happened at a time in the year where the actual conversion factor was significantly different from the average we might look for a way to apply the actual factor. Off the top I am not sure how that would be done.

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  12. I am a Canadian tax accountant specializing in cross-border tax issues. I have significant tax planning and compliance experience in advising Canadian residents investing in US rental properties. I just want to add my two cents and confirm that there are double taxation issues for Canadians owning their US rental properties through US LLCs. Before unwinding the US LLC structure, it is important to consult a Canadian tax professional with cross-border tax experience as there are both Canadian and US tax considerations.

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  13. Hi, Just found this and have a few questions for you. What is the deal with Article VI of the US/Canada tax treaty? Per one accountant I spoke with, if you are paying US taxes on income earned in the US, you do not have to pay taxes in Canada. When I went to the CRA website and looked at the form T2209 (Federal Foreign Tax Credit) it says this:
    This credit is for foreign income or profits taxes you paid on income you received from outside Canada and reported on your Canadian return. Tax treaties with other countries may affect whether you are eligible for this credit.
    Note You may have deducted an amount on line 256 of your return for income that is not taxable in Canada under a tax treaty. In that case, do not include that income in your "Net foreign non-business income" (line 433) or in your "Net foreign business income" (line 439). Also, do not include any foreign tax withheld from it in your "Non-business income tax paid to a foreign country" (line 431) or in your "Business income tax paid to a foreign country" (line 434).

    I am trying to figure out if this accountant was correct or not. In which case perhaps you don;t need to put it on the return for the CRA (whether the property is held in your individual name or inside of a company/partnership structure). Anyone else have any ideas?

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    1. My understanding is that if you are a Canadian resident for tax purposes, and you earn income in the US, you need to report it to both the U.S. and Canadian tax authorities on income tax returns. The mechanism that prevents you from experiencing double taxation is the Foreign Tax Credit (FTC). The tax treaty between Canada and the U.S. says that (with caveats and details) if you pay tax to the U.S., you can claim it back via the FTC on your Canadian return. As I mentioned, there are lots of details and caveats, but primarily two main things: the FTC is a credit back against tax of the same type, and you can't claim back more than the tax you are paying (of that type) in Canada. Check out the related post in April 2013 regarding US income on Canadian tax forms.

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  14. I have a question about 1065 State filing. I am Canadian resident, I registered a LLP in Wyoming state, this LLP owns vacation home in Florida. I have filed IRS 1065 return, my LLP is reported as foreign partnership in 1065. The question is, do I have to file the state 1065 for Florida?

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    1. I have no specific knowledge of Wyoming or Florida, but have a few thoughts: (1) I would check whether your LLP is really considered foreign. In Arizona, and Federally, I believe "foreign" refers to the entity (LLP) not the partners/owners. If the LLP is organized in the US I believe it is "domestic" from the perspective of the U.S. tax authorities. (2) I would check the filing requirements for Wyoming and Florida. My guess is that Wyoming would want you to file because your LLP is is a Wyoming entity and Florida would want you to file because the income is occurring in Florida. I believe most states subscribe to a common "apportionment" method based on where the sales (revenue) occurs and where the property is situated to determine which state gets the income tax. Don't take my guess though. check the filing requirements. In Az the return is called a 165 and there are accompanying instructions that list the requirements. Any other readers have an opinion?

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  15. As a rental property owner in US which tax return I shall file first, Canadian or American. If FTC is to be claimed how can I claim before before IRA assessment of 1040NR

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    1. I use this order:
      - Figure out US property accounting
      - US tax returns (takes accounting as an input)
      - Canadian tax returns (takes accounting and US tax paid information as an input)
      I do not wait for the IRS to process the US tax returns before submitting in Canada...in fact the IRS rarely sends anything back.

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  16. Great blog We haven't yet filed our Canadian Taxes this year, but I will try the "foreign income" route to see how it works in practice. This will imply that we are not doing a separate depreciation calculation in Canada.Thanks for sharing........

    Save Your Business Tax In UK | Birmingham and Manchester Taxation Specialist

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  17. My wife and me jointly own a property in florida since July 2016. The property management company paid income only to me, against my ITIN via 1042S. We are yet to apply for my wife's ITIN. Does my wife also need to file taxes in the US with half of the income being allocated to her? Do we user a seperate 1040 NR for her and me?

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    1. This comment has been removed by the author.

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    2. I am not a tax guru and really not qualified to answer, so I can only have an opinion. It sounds like you own the property in your own names rather than in an entity and that you are non resident "foreigners". So, in that case I would agree that you file the income on 1040NRs. Since you are non resident foreigners you would then need to file separate 1040NRs as I do not think foreigners can file joint returns.

      That brings us to what to do about the incorrect tax statement from the Property Manager. I would probably ask them if they can correct it and send half to each of you if that is the correct split. There is not much time left before the filing deadline though. So if they can't do that I would call the IRS to see if they can advise how to handle it. Failing all that I would probably just split it myself, and include a written explanation with the return.

      One loose thread...the missing ITIN. I think the normal procedure is to apply for it with your tax return anyway. As I recall you leave the field blank, and send an application for the ITIN with your return...and you mail the return to a different address. Check the current procedure though as it may have changed. Read the prerequisites carefully to ensure compliance. As a Canadian I think the item that caused the most rejections of ITIN applications was having some required form notarized in Canada and the Canadian Notaries not being recognized because Canada didn't sign the Geneva Convention or some such. You may nave to get it notarized at a US Consulate or if you are visiting the US if this is your case.

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  18. tax deductible interest rules of personal real estate loans are complex. thanks for share that article.





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