Selling the US Vacation Property
With real estate prices soaring in the US and the Canadian dollar falling in value against the greenback, Canadians who invested in a vacation property in the US may be tempted to sell their US cottage and purchase a Canadian cottage instead.
But it’s important to understand the tax consequences on both sides of the border before they do.
Here’s an example to illustrate: Sarah and George purchased a home in Phoenix in 2011 for $190,000US ($191,000CAN), including costs. Today, the home is worth $290,000US (about $358,000CAN). This represents an accrued gain of $167,000CAN (a $100,000 US gain in the States). The value of the couple’s home in Canada, meanwhile, has increased only $20,000 over the same time period. What are the tax consequences if the couple sells the US property and uses the proceeds to purchase a cottage closer to home?
The disposition of the US property will create a taxable capital gain to be reported on a US return ($100,000 US). In Canada, the capital gain could be minimized by designating the US property as the couple’s principal residence for all but one year from 2011 to 2015. However, the elimination of the capital gains tax on the Canadian return comes at a price. If the gain is taxable in Canada, the US taxes paid could be claimed as a foreign tax credit.
But if the gain is tax-free in Canada, the foreign tax credit cannot be claimed. At the same time, claiming the US property as a principal residence means the gain on their Canadian home becomes taxable.
Since the US tax cannot be eliminated, the only way to ensure that the same gain is not taxed in both jurisdictions is to make sure that at least $100,000US of the capital gain is taxed in Canada in the year of sale. That’s about $123,000CAN, depending on the exchange rate at the time of the sale.
With a $167,000CAN gain, 26% of the gain could be exempted and the couple could still claim the foreign tax credit. By choosing to designate the US property as their principal residence for one year, 33% ([1+1]/6) of the gain would be exempt in Canada, limiting the foreign tax credit claim.
By choosing not to designate the US property as their principal residence, 1/6 of the gain would be exempt, allowing the full foreign tax credit.
Of course, in this or any other case, the actual amount of taxes payable in the US and Canada would have to be determined to ensure that choosing not to claim the principal residence exemption for any of the years owned results in the lowest overall taxes payable.
This type of transaction, therefore, should be reviewed well in advance by a Tax Services Specialist to get the best tax results over time for the sale or deemed disposition of both residences.