If you are a Canadian resident (not a U.S. citizen, Green Card Holder or U.S. tax resident) who owns a U.S. rental property you have a couple of options available to you regarding the U.S. federal tax compliance related to your U.S. source rental income.
Before we look at the options available, it is important to understand that income from real property is generally taxed first based on the location of the property (United States), not the residency (Canada) of its owner. It will subsequently be taxed in Canada based on the residency of the owner, who may be eligible for a credit for all or part of the foreign (U.S.) taxes paid.
1) Taxed at 30% of gross rents collected. U.S. rental income earned by a non-resident of the U.S. is subject to a 30% withholding tax. The tenant or a property manager, acting as a withholding agent, is required to withhold and remit 30% of the gross rents to the Internal Revenue Service. The agent would then report the gross rents and withholding taxes remitted on Form 1042-S, Foreign Persons U.S. Source Income Subject to Withholding.
If the taxpayer so chooses, this can be the final federal tax obligation related to the rental income. It would not be necessary to file a U.S. Federal Income Tax Return.
2) Net Rental Income taxed at U.S. Graduated Rates. Under this option, the owner of the U.S. property would file a U.S. Federal Non-Resident Return, Form 1040NR, reporting the gross rents collected and claiming the related expenses incurred to earn the rental income. Mortgage interest, property taxes, insurance premiums, utilities, repairs and maintenance costs and management fees are some of the expenses that can be claimed. A statement electing to have the rental income treated as effectively connected with the conduct of a trade or business in the United States would be attached to the return.
Under this option, the taxpayer would advise its withholding agent of it’s election by providing them with a completed Certificate of Foreign Persons Claim That Income is Effectively Connected with The Conduct of a Trade or Business in the United States, Form W-8ECI. Once this form is provided to the withholding agent, they are no longer obligated to withhold or remit 30% of the gross rents collected.
Form 1040NR is normally due by June 15th of the subsequent tax year. The due date may be extended to October 15th by filing an Application for An Automatic Extension of Time to File U.S. Individual Income Tax Return, Form 4868. If Form 1040NR is not filed within 16 months of the returns original due date, the above election may not be available to the taxpayer and they could be subject to tax on their gross rents at 30%.
In order to file Form 1040NR, an U.S. Individual Taxpayer Identification Number is required; this can be obtained by completing Form W7 and providing the required identity supporting documents.
When determining which option is best some of the factors that should be considered are:
The cost of compliance; i.e: the cost of completing the related U.S. returns and/or Forms.
The U.S. graduated tax rate applicable to the net rental income vs. the 30% withholding rate.
The Canadian rule that limits a foreign tax credit claim to the lessor of the actual foreign taxes paid or the Canadian taxes payable on the foreign income.
Other differences between U.S. and Canadian reporting requirements for such income, related expenses and losses.
Generally, Option 2 is preferable as it usually results in an overall lower cost even though there are additional tax compliance costs.
Note that if the property is owned in a state that imposes personal income tax, it may be necessary to file a state income tax return as well.
If you are a Canadian resident who owns a U.S. rental property and require assistance in determining which option is best for you and/or assistance with completing related U.S. Federal and State personal income tax returns and/or forms please contact our Cross-Border Tax Services Manager, Jay P. Trudell, CPA, CA, CPA (Illinois) at 519-539-4717 extension 205 or email email@example.com.