Given the uncertainty of how a prolonged COVID-19 pandemic will affect Canadians’ travel plans for the foreseeable future, snowbirds across the country are concerned about the implications of holding or selling their vacation properties in the United States. As many didn’t anticipate the need to change their winter migration patterns, some are turning to their financial advisors to help them figure out what to do.
“With travel restrictions in place, just making sure your property is safe, secure and maintained is a challenge right now,” says Darren Coleman, senior vice-president, private client group, and portfolio manager at Coleman Wealth, a division of Raymond James Ltd. in Toronto. “[Property] insurance policies require that the property is checked regularly. Lawns need to be cut and so on. And if your clients can’t go, they’ll need to have a trustworthy circle of care there than can [handle these tasks].”
One way to cover the costs of holding the property is to rent it. Not only can it pay the expenses, but it can also provide some extra cash to fund whatever these clients’ stay-at-home wintertime replacement recreations might be.
“Paying expenses using U.S. dollars from rent is far better than using Canadian dollars from your retirement income,” says Terry Ritchie, director of cross-border wealth services at Cardinal Point Capital Management Inc. in Calgary. “But renting can create a lot of headaches as well – especially in terms of accounting and income taxes.”
Both Canada and the U.S. allow property owners to subtract any operating expenses from rental revenue to determine the taxable income relating to the property. However, if months of vacancy or a low rent scheme ends up incurring a loss, how it’s applied for tax purposes differs greatly in both countries, he explains.
In Canada, if expenses exceed revenue and produce a loss, that loss can be used to reduce the client’s total annual income and tax liability. In the U.S., losses from income properties can only accumulate, year after year, until the owner sells the property. Only then can any cumulative losses be applied – and only to reduce any capital gains from the sale. If the property sells at a loss, the accrual becomes pointless.
In contrast, if a client decides to sell the property, there’s another set of tax rules up for consideration.
“There is no obligation to do any tax reporting when you buy a property in the U.S.,” Mr. Ritchie says. “If you’re selling property, it’s [considered to be] a taxable event whether there’s a gain or a loss and must be reported to the [Internal Revenue Service (IRS)].”
He says the only touchpoint most seniors have with the IRS is the annual filing of Form 8840, which proclaims them as Canadian rather than U.S. taxpayers for the 183 days or less that they’re entitled to stay in the U.S. each year.
“If you are not a U.S. taxpayer, there’s a federal withholding tax of 10 to 15 per cent of the proceeds of any sale of more than US$300,000. If the sale is under that amount, there are no withholding taxes unless the buyer intends to rent the property,” Mr. Ritchie says, adding that the withholding taxes apply, regardless of the property’s price, in that case.
For some snowbirds, the withholding taxes could end up being higher than the capital gains taxes on the sale, creating a tax refund situation. Even if there are capital losses, resulting in no tax liability at the end of the year, the withholding taxes are still held back and dispersed to the IRS upon the closing of the sale.
Mr. Ritchie says advisors can help their clients reduce or eliminate the withholding taxes by helping them submit Form 8288-B to the IRS as part of the closing process on the property, but he adds it might not be worth the time.
“It may take longer to get the form processed than it does to close the sale,” Mr. Ritchie says . “If [clients] don’t have an individual taxpayer number in the U.S., they’ll have to apply for one before filing for the exemption. That requires their passports to be certified in Canada to verify their identity. And all [the government agencies] take their sweet time.”
As a result, he advises his clients to skip the application for exemption, let the IRS take the 10 per cent and hope and pray they’ll get it back.
“They’ll have to file a tax return in the U.S., and by the time they get their refund, they might make some extra money converting the U.S. dollars to Canadian depending on the exchange rate at the time,” he adds.
The taxes don’t stop there either. If the snowbirds plan to move the contents of their vacation property to Canada, there are import taxes to consider. You can’t just load your furniture, local vehicle, valuable art or wine collection into a truck and bring it across the border without facing the highest amount of customs charges, Mr. Coleman says.
“I had a gentleman moving [back] to Canada who was planning to bring his wine collection, worth tens of thousands of dollars, with him through the border,” he says. “If I didn’t look into it, the taxes would have been astronomical. I found someone who understands import rules and imported them correctly, saving my client thousands of dollars.”