In Arizona, Canadians have recently surpassed Californians as the largest purchasers of residential real estate. This should not be too surprising considering the weak US dollar and cheap Arizona real estate values.
But with such a large influx of Canadians acquiring rental real estate, they must consider the tax consequences. Canadian investors must make sure they understand applicable US tax laws and also make sure that they maintain compliance to avoid penalties and interest.
The general tax rule is relatively straightforward. When foreign nonresidents (including Canadians) receive passive rental income from real estate held in the U.S., the Internal Revenue Service (IRS) imposes a 30% tax on the gross rental payment amounts. This tax does not consider any deductions (property management fees, repairs, insurance, etc).
However, individuals may elect to have their rental activity taxed as if it was “effectively connected with a U.S. trade or business”. This is done by filing an election statement to your US tax return in the year the property is first rented out. If you make this election, you can claim deductions attributable to the real property income and only your net income from real property is taxed.
With proper planning, many Canadian investors will find themselves being assessed tax at the same rates as US individuals. These rates begin at 10% and go up to the highest rate of 39.6%. Rental real estate will often generate depreciation expense and other direct expenses, so most investors will only pay rates at the lowest level of 10% (if they pay tax at all). The US tax code also has a very favorable long-term capital gains rate of 15% (subject to certain income) that will apply upon the sale or disposition of the property.
In addition to federal taxes, Canadian investors will also have state taxes to consider. The US has of course 50 states, but only 43 have a state income tax. But some states impose a transfer tax and other assessments that can complicate the situation.
Navigating US tax law and filing the applicable tax returns is not easy. Before you acquire real estate you must consult with a CPA and/or a tax professional. At Sundin & Fish, PLC, we work extensively with real estate investors from Canada and we are always available to review your situation and determine the proper course of action.
Education is important to the process, so make sure you have a professional on your side. Call us today at 480-361-9400.
We work with worldwide real estate investors, including (but not limited to) investors from Canada, France, Israel, Australia, Germany, Netherlands, United Kingdom, Sweden, Russia; Japan, China, and Switzerland.