Owning real property on both sides of the border can create a confusing tax situation.
Consider this example. Stefan and Jane are married and live in Vancouver. Jane is a Canadian citizen while Stefan holds both US and Canadian citizenships. In 1994, shortly after getting married they bought a house for $250,000 (all figures Canadian for simplicity’s sake) which they own jointly. Thanks to the Vancouver housing market the house is worth $2.25 million. Their increased net worth prompted Jane to buy a condo (in her own name) in Arizona, next to Stefan’s favorite golf course.
Now Stefan and Jane might owe some US tax if they want to sell the house or the condo. Under Canadian tax rules, the sale of their principal residence — their house — is free of capital gains tax (the tax due when an asset you own has appreciated in value).
American rules are different, and as a dual citizen, Stefan is subject to both US and Canadian tax rules. In this case, the gain on the house would be $2 million (the purchase price of $250,000 is subtracted from the sale price of $2.25 million to arrive at the capital gain). Stefan’s half of that is $1 million. Under US tax rules, Stefan is allowed to exclude $250,000 worth of capital gain income from tax. But that leaves $750,000 of capital gain income that is still subject to tax at a rate of 23.8% (approximately $178,500 of tax due). This might come as a surprise to Stefan and Jane. Like other couples, they may have thought — correctly under Canadian rules — that the sale of their principal residence was tax free. To avoid the American taxes, Stefan may be able to give his share of the house to Jane prior to the sale (and preferably years before the sale), but he should consult with a tax advisor before doing so as this will have US gift tax implications.
Stefan’s ownership of the house isn’t the only US tax issue the couple has to grapple with. Jane owns a condo in the US. If she sells this condo, she will have to pay both US and Canadian capital gains tax on the sale. However, she can use the US tax paid as a credit to offset the Canadian tax on the sale.
American estate taxes are another potential problem. Jane is Canadian, but because the property is located in the US, her estate may be subject to American estate taxes if she still owns the condo when she dies. US rules exempt the first USD $60,000 of property that Jane owns in the US from US estate tax. The Canada-US Tax Treaty offers further relief that should prevent Jane from owing US estate tax. If she does have some exposure, there are strategies (including owning the US property through a trust) that Jane can use to reduce her exposure to US estate tax. The tax issues surrounding the ownership of US real estate are complex, so the couple should seek professional tax help before purchasing property.
Jane and Stefan need to pay careful attention to the tax rules so that their real property doesn’t become a real tax problem.