Tax Considerations for Non-Residents Owning Canadian Real Property
This article identifies some of the tax issues non-resident Canadians may face when owning Canadian real property. Since tax implications will vary with each individual’s specific circumstances, professional tax advice should be sought before acting on any information provided in this article.
Canada’s real estate market is a well-known hotspot for non-resident investors, burgeoning cities like Vancouver and Toronto have topped the list for many as preferred investment areas. The influx of foreign capital has prompted the controversial Foreign Buyers’ Tax resulting in a flurry of questions and concerns.
Many individuals living outside of Canada, including former Canadian residents and individuals that have never resided in Canada, may consider purchasing Canadian real property in the form of homes or seasonal residences. Some former Canadian residents may also continue to own real property in Canada after becoming non-residents, either for investment purposes, or so they will have a home to move back to if they choose to return to Canada. Whatever the reason for owning Canadian real property as a non-resident, there are a myriad of tax considerations that should be taken into account. Very often, individuals owning Canadian real property as non-residents do not handle their affairs properly, resulting in significant exposure to Canadian tax.
Canadian Real Property and Canadian Residency for Tax Purposes
It is a common misconception that the mere ownership of real property in Canada causes one to be viewed as a Canadian resident for tax purposes by the Canada Revenue Agency (CRA). Although the ownership of Canadian real property could be seen as a significant residential tie to Canada, there are steps that can be taken to mitigate this. For example, the real property could be rented to an arm’s length party at fair market value, preferably under a long term lease. By doing so, CRA should not view this as a significant residential tie to Canada when making a residency determination. On the other hand, leaving a vacant home in Canada available for regular and continuous use could send the message to CRA that an individual may be a resident of Canada for tax purposes. As well, renting the home to family members, or simply allowing family members to use the home rent-free is likely to send a similar message to CRA. If an individual is found to be a resident of Canada for tax purposes, he/she is taxed on worldwide income which could significantly increase the individual’s overall tax liability.
Principal Residence Exemption
For most Canadians departing Canada, the real property they own in Canada, up to the time of their departure can often be designated as their principal residence. If the home is sold prior to leaving Canada, the full principal residence exemption should be available, with some exceptions, resulting in no tax on the sale of the home. Complexities of selling a home that formerly qualified as a principal residence arise when the property is sold as a non-resident of Canada. The reason for this is that the home cannot be designated as an individual’s principal residence for the years that they are not a Canadian resident for tax purposes, with the exception of years where they were a Canadian resident for tax purposes for at least part of the year. The result of this is that the principal residence exemption will not fully offset the capital gain on the sale of the property and a taxable gain may arise in Canada.
Change in Use Rules
At the time rental activity commences with a former personal use property, there may be a deemed “change in use” of the home from personal use property to an income producing property under Canadian tax legislation. This may result in a capital gain which will often be offset by the principal residence exemption. However, there is an election that can be filed that allows an individual to take advantage of the principal residence exemption to potentially reduce a future capital gain on the sale of the property. In some cases, this can be of benefit if the home is expected to increase in value for years that the individual owner is a non-resident of Canada. Alternatively, if the property is not expected to increase in value while the individual owner is a non-resident of Canada, the election may not be beneficial. There are many other complexities involved in the decision of whether or not to file the election, which a tax professional should advise on.
Earning Rental Income in Canada
If the home is rented while an individual is abroad the rental income is often large enough to cover most of the expenses incurred on the home which can be a significant benefit. The common expenses involved in maintaining a home are property taxes, mortgage interest, utilities, property management fees, and repairs and maintenance. It will be necessary to track and keep proper documentation to support these and other expenses incurred to earn the rental income.
Although there could be a capital gain on the eventual sale of the property, the home is being looked after, while the owner is living abroad. The individual has the benefit of renting the home with little to no tax depending on the net income of the property. If the home is re-occupied on a future return to Canada, the individual may benefit from a lower capital gain on the eventual sale, the longer the individual resides in the home. This assumes the proper tax election is filed in a timely manner.
Not surprisingly, there are withholding tax and annual non-resident rental filing requirements that individuals must comply with if they own real property in Canada as a non-resident and earn rental income from it. If these requirements are not properly met, there could be significant interest and/or penalties imposed by CRA for non-compliance. Additional filing requirements and capital gains tax may result when the property is disposed of even if the property is not being used as a rental property.
Unfortunately, many Canadian expatriates rent their homes but do not properly abide by the tax withholding and/or tax filing requirements because they are often not aware that these rules exist. A detailed review of the filing and withholding requirements are beyond the scope of this article. However, you should at least be aware that income from the rental of Canadian real property is taxable in Canada, even if you are a non-resident of Canada for tax purposes, so you should ensure that the tax filing and remittance requirements are met.
Tax on Sale of the Property
If the Canadian real property is sold while the individual is a non-resident of Canada, there may be tax owing as a result of the disposition. However, whether there is tax on the sale or not, the individual must meet certain filing and remittance requirements. The individual must file a special form and remit the appropriate amount of tax to the CRA. If these requirements are not met, the purchaser may be required to remit the tax based on the total purchase price, which can severely affect an individual’s cash flow. There could also be penalties involved. Once the CRA receives the form and the remittance, they will issue a clearance certificate to the purchaser as proof that the non-resident vendor has met the necessary requirements. The vendor must then send the form to the CRA based on the required timeline. The individual is still required to file a Canadian non-resident income tax return to report the re-sulting disposition. A tax refund may arise because the overall Canadian tax rate will often be less than the required tax remittance. In addition, the selling costs are not taken into account when the original tax remittance amount is determined, which will usually further reduce the overall tax. If the property is sold after the individual re-establishes Canadian residency, tax may still result on the sale, though the filing and withholding requirements are less onerous.
Owning a property as a non-resident requires some foresight. It could be seen as a primary residential tie if it is not rented to an unrelated individual/party at market value so this should be considered. There are also considerations around the change in use from a personal use property to an income producing property, and possibly back to a personal use property if the individual returns to reoccupy it. Finally, there are tax withholding and tax reporting requirements on the rental income as well as issues around the sale of the property as both a resident and a non-resident. These issues, and others that cannot be covered in this article, should be considered when an individual becomes a non-resident of Canada for tax purposes as ignorance could result in a significant tax cost. As always, professional tax advice in dealing with these complex issues is a must.
By Arun (Ernie) Nagratha, CA
With edits by Wayne Bewick, CA, CFP, CPA(IL) and C. Todd Trowbridge, CA
Ernie Nagratha is a Partner at Trowbridge. With a focus on International Tax Services, our expertise allows you to maximize your opportunities and minimize your tax barriers. Email: firstname.lastname@example.org