Selling a property in the United-States can bring about unexpected costs for foreigners (i.e. Canadian citizens). Under Section 1445 of the Internal Revenue Code (IRC) and the American Foreign Investment in Real Property Tax Act (FIRPTA), the purchaser of real property owned by foreigners must withhold 15% of the gross sale proceed and forward the amount to the Internal Revenue Agency (IRS). The purchaser has a 20-day deadline from the sale's conclusion to remit the amount withheld to the IRS. The Canadian must then file a U.S. tax return to be eligible to have the money returned.

Canadians who own property in the United-States are often not required to file a U.S. tax return unless they are using the property to generate rental income. Consequently, Canadians who own vacation homes or condos in the U.S. are commonly surprised to learn that they must file a tax return when they sell their property.

It is important to highlight that the withholding obligation under the FIRPTA is not a tax but rather a withholding against capital gains tax. In other words, the amount to be withheld does not represent the foreigner’s tax liability towards the American authorities. It is simply a mechanism used by the IRS to ensure that the capital gains tax will be paid to them, should there be any.

When filing a tax return in the U.S., the Canadian vendor may simultaneously apply for the reimbursement of either the entirety or a portion of the withheld sale proceeds. The amount claimed in the application is dependent on if the sale resulted in capital gains or capital losses or if the withheld portion exceeds the capital gains liability. It should be noted that the process by which a foreigner is reimbursed can take upwards of a year from the closing date of the transaction.

Exempted transactions

Sales of U.S. property by foreigners can qualify for an exemption for either the entirety or a portion of the withholding under certain conditions.

Exemption #1

The first exemption applies if the following criteria are met:

I. the amount realized is US$300,000 or less;

II. the transferee/buyer has definite plans to use the property as a principal residence; and

III. the transferee/buyer is an individual (or individuals) and not a corporation or other legal entity.

The IRS has provided specific guidelines on what is meant by the term "definite plans to use the property as a residence". For the exemption, the IRS considers a property to be used as a residence if, for 24 months after the closing date, the buyer intends to use the property for personal use 50% of the number of days the property is in use. It should be highlighted that the days where the property is vacant do not count towards the 50%.

For example:

John and Yvette are Canadian residents who own a Condo in Sunny Isles, Florida. They like to escape the cold during the winter months and live in Florida. They have recently decided to sell the property. They have received an offer for an amount of US$250,000.

Carmen, the purchaser who is also a Canadian resident, intends to stay in Florida for 4 out of the 12 months of the year. During the 8 months where she is back in Canada, the condo will be rented out for 4 months. Thus, 4 out of the 12 months, the condo will be completely vacant.

In the example above, the exemption would clearly apply as all the criteria are met (We are assuming she will be doing this for the next 2 years):

I. The property is sold for less than US$300,000

II. The buyer will be living in the property 4 out of the 8 months it is in use (4 months out of 8 months = 50%)

III. The purchaser is an individual and not a corporation.

However, if the buyer did not intend to proceed in this manner for two consecutive years, the exemption would not apply. Additionally, if the purchaser intended to use the condo as a rental property for 6 months and only use the condo for 2 months personally, the exemptions would also not apply as she would be using the property only 25% of the time as a residence (2 months out of 8 months = 25%).

Exemption #2

The second exemption allows the withholding to be reduced from 15% to 10%. It applies If:

I. the property sells for less than US$1million but more than US$300,000; and

II. the buyer intends to use the property for personal use at least 50% of the time the property is in use for the 24 months following the purchase.

Exemption #3

The third exemption differs from the first two because it does not reduce or eliminate the withholding. Rather, it prevents 15% of the gross sale proceeds from being automatically remitted to the IRS.

This exemption finds its utility when the seller's capital gains tax liability is significantly lower than the amount that is to be withheld or that the property has not produced any capital gains (sold at a loss). In these circumstances, the seller may elect to apply for an 8288-B withholding certificate.

The withholding certificate must be submitted before the closing date of the sale. The certificate includes calculations demonstrating that the seller’s expected capital gains tax is significantly lower than the amount that is to be withheld. If submitted on time, the escrow agent (the person who withholds the money) is authorized to keep the funds for 20 days without having an obligation to remit to the IRS. The processing delay by the IRS can take up to 90 days.

Once processed, the IRS issues the withholding certificate to the seller and the escrow agent. Depending on the tax liability, the certificate can either reduce the amount to be withheld or provide a total exemption. The escrow agent must then release the funds to the seller directly. If there is an amount to be remitted to the IRS, he must reduce the amount given to the seller and remit the IRS amount.

See the example below on the application of a withholding certificate:

John and Mary own a condo in Florida. They purchase in 2009 for US$300,000. They have decided to sell their property for US$400,00. According to FIRPTA, US$60,000 (15% of 400,000) must be withheld on the sale. John and Mary decide to apply for a withholding certificate.

Because they made the application before closing the sale, the escrow agent charged with the sale is authorized to hold the 15% in escrow even though the sale is now closed. He will hold this amount during the time the application is pending.

90 days later, the IRS issues the withholding certificate that indicates that the required withholding amount is US$15,000, corresponding to the actual imposed capital gains taxed. The agent is now charged with giving John & Mary the remainder of the money after giving the IRS US$15,000, thus US$45,000 (60 000 – 15 000 = 45 000).

It is important to remember that a withholding certificate does not exempt the purchaser from filing a U.S. tax return. Furthermore, when Canadians sell U.S. held property, they must include the sale in their Canadian Tax Return.

In summary

The above information provides a brief overview of the costs of selling U.S. real estate by Canadian citizens. At Medtiax, our experienced lawyers and tax specialists can help ensure the closing costs associated with U.S. property sales be reduced or eliminated using the abovementioned exemptions, as applicable.