US Real Estate Tax Accountant

FIRPTA (Foreign Investment in Real Property Tax Act) is a US tax law that requires buyers of US real estate to withhold 15% of the sales proceeds when the seller is a non-resident alien, such as a Canadian. This withheld tax is remitted to the IRS and reported on Form 8288-A. The seller can recover the withheld amount by filing a US non-resident tax return (Form 1040-NR). FIRPTA ensures that the IRS can hold non-resident aliens accountable for taxes on profits generated from US property sales.

You can deduct several types of expenses from your US rental income, including mortgage interest, property taxes, utilities, insurance, repairs, property management fees, tax preparation fees, depreciation, and advertising. It's important to keep copies of all your receipts in case of an audit, as the IRS may require documentation to validate the expenses deducted. Rental income and expenses are reported on Schedule E of a US 1040 non-resident tax return. For assistance in maximizing your tax deductions, consult our US real estate tax accountants in Toronto and Mississauga, Canada.

Canadian investors should generally avoid purchasing US real estate through a US LLC, as this can lead to double taxation. The CRA treats US LLCs as foreign corporations, while the IRS classifies them as pass-through entities. This discrepancy limits the foreign tax credit Canadian investors can claim to the lesser of 15% of the distributions received from the LLC or the US federal and state income tax paid. Often, the federal and state taxes exceed 15% of the distributions, resulting in unrecoverable excess taxes and double taxation. Our real estate tax services can help ensure you invest in US real estate in a way that avoids double taxation.

The CRA imposes an estate tax on Canadian taxpayers upon their death, which is essentially a capital gains tax on the accrued gains of their assets. Canadians are deemed to have sold their assets at fair market value at the time of death, triggering a capital gains tax. To minimize estate taxes, Canadians can establish a Canadian corporation owned by a Canadian Family Trust to purchase US real estate. This structure avoids estate tax because both the trust and the corporation continue to exist after the individual's death, preventing a deemed disposition of assets. Our real estate tax accountants in Mississauga and Toronto, Canada can assist you in creating a Canadian corporation and Family Trust to effectively minimize estate tax.

Depreciation on U.S. rental properties is calculated using the Modified Accelerated Cost Recovery System (MACRS), which allows property owners to recover the cost of the property over a specified period. For residential rental property, the recovery period is 27.5 years, while for nonresidential real property, it is 39 years.

As a Canadian resident and non-resident alien of the U.S., you can claim a foreign tax credit for the U.S. capital gains tax you paid on the sale of the vacant land. This credit helps avoid double taxation on the same income. Here’s how to claim it:

How to Claim the Foreign Tax Credit: 

1. File Canadian Tax Return: Report the capital gains on your Canadian tax return (T1) and calculate your total tax liability.
2. Complete Form T2209: Use this form to calculate the foreign tax credit available for the taxes you paid to the U.S. on the capital gains.
3. Claim the Credit: Include the calculated foreign tax credit on your tax return to reduce your Canadian tax liability.

A 1031 exchange, also known as a like-kind exchange, is a tax-deferment strategy under U.S. Internal Revenue Code Section 1031. It allows real estate investors to defer paying capital gains taxes on an investment property when it is sold, as long as another similar property is purchased with the profit gained by the sale. This provision applies only to investment properties, not primary residences.

Key Features of a 1031 Exchange:

1. Like-Kind Property: The properties involved in the exchange must be of "like kind", meaning they are similar in nature and purpose (e.g., both must be investment properties).

2. Timelines: The seller must identify a replacement property within 45 days of selling the original property and must complete the purchase within 180 days.

3. Tax Deferral: Taxes on the capital gains from the sale of the original property are deferred until the replacement property is sold.

Practical Examples

Example 1: Billy’s 1031 Exchange

Billy, a resident of Canada and non-resident of the US, sells a rental property in Florida for $500,000. He originally purchased the property for $300,000, making a $200,000 profit.

Billy finds and purchases a new rental property in Texas for $600,000 using the proceeds from the sale.

Outcome:

By completing the 1031 exchange, Billy defers the $200,000 gain from the Florida property. He does not pay any capital gains tax at the time of the exchange.

Example 2: Sarah’s 1031 Exchange

Sarah sells a commercial property in New York for $1,000,000. She bought it for $600,000, making a $400,000 profit. Sarah purchases a new commercial property in California for $1,200,000.

Outcome:

Sarah defers the $400,000 gain by using the 1031 exchange, avoiding immediate capital gains tax.

Double Taxation Implications for Canadians

For Canadian residents who engage in a 1031 exchange, the deferred gain can lead to double taxation when the U.S. tax obligations intersect with Canadian tax law. Here’s how:

1. U.S. Taxes: When Canadians sell their U.S. properties and defer the gain through a 1031 exchange, they will owe U.S. capital gains tax when they ultimately sell the replacement property. This means that the gain from the original property is not taxed at the time of exchange but will be taxed later.

2. Canadian Taxes: Canada taxes its residents on their worldwide income, including capital gains from the sale of foreign properties. The CRA does not recognize a 1031 exchange so Billy and Sarah will both pay Canadian capital gains tax when they sell their original properties. In addition to this, when Billy and Sarah eventually sell their replacement properties, they will face capital gains tax obligations in both Canada and the US.

Summary

A 1031 exchange allows for the deferral of U.S. capital gains taxes, but for Canadian residents, it can create a situation where they eventually face double taxation when realizing the gains from the sale of the replacement property. This underscores the importance of careful tax planning and consideration of cross-border implications for real estate transactions. Consulting with cross-border tax professionals experienced in both U.S. and Canadian real estate tax law is advisable.

Wholesaling in real estate involves finding properties (often distressed or undervalued), getting them under contract, and then selling that contract (or assigning it) to another buyer, usually an investor, at a higher price. The wholesaler profits from the difference between the purchase price and the sale price, often without ever actually owning the property.

Tax Implications of Wholesaling for the IRS

The IRS generally treats profits made from wholesaling real estate as ordinary income. This means that the profits are subject to ordinary income tax rates rather than capital gains tax rates. Additionally, if the wholesaler is classified as a business (which is common), they may also be subject to self-employment tax on their profits.

How Profit is Taxed

1. Ordinary Income Tax: Profits from wholesaling are taxed as ordinary income based on the taxpayer's income bracket.

2. Self-Employment Tax: If wholesaling is considered a business activity, the wholesaler will also owe self-employment tax on their net earnings, which is currently 15.3% (covering Social Security and Medicare).

Practical Examples

Example 1: Billy the Wholesaler

Contract Price: Billy finds a distressed property and negotiates a purchase contract for $200,000.

Assignment Fee: He then finds an investor who is willing to pay $250,000 for the contract.

Profit: Profit=Sale Price−Contract Price=250,000−200,000=50,000

Tax Implications:

Ordinary Income Tax: If Billy's ordinary income tax rate is 24%, his tax on the profit would be: Tax=50,000×24%=12,000

Self-Employment Tax: Assuming the entire profit is subject to self-employment tax: Self-Employment Tax=50,000×15.3%=7,650

Total Tax Liability:

12,000+7,650=19,650 - Billy’s total US tax liability is $19,650.

Example 2: Sarah the Wholesaler

Contract Price: Sarah finds another property under contract for $300,000.

Assignment Fee: She sells the contract to an investor for $350,000.

Profit: Profit=350,000−300,000=50,000

Tax Implications:

Ordinary Income Tax: If Sarah's ordinary income tax rate is 32%, her tax on the profit would be: Tax=50,000×32%=16,000

Self-Employment Tax: Assuming the profit is subject to self-employment tax: Self-Employment Tax=50,000×15.3%=7,650

Total Tax Liability:

16,000+7,650=23,650 - Sarah’s total US tax liability is $23,650.

Summary
In both examples, profits from wholesaling real estate are taxed as ordinary income. If the wholesaler is deemed to be self-employed, they will also be liable for self-employment tax. This tax structure highlights the importance of understanding tax liabilities for real estate wholesalers, as it can significantly impact their net earnings. Wholesalers should consider working with a real estate tax accountant in Toronto and Mississauga to ensure compliance and optimize their tax situation.