What Canadians need to know about U.S. taxation of rental property income
Note: Prior to implementing any strategies contained in this article, individuals should consult with a qualified tax advisor, accountant, legal professional, or other professional to discuss implications specific to their situation.
Even though you are a Canadian citizen and resident, you are subject to U.S. income tax on any rental income you receive from your U.S. real estate property. To comply with this Internal Revenue Service (IRS) annual tax reporting requirement, you can choose one of the following two options.
OPTION 1 – 30% withholding tax on gross rents
You can choose to have your gross rental income taxed at a flat 30%, but this option does not permit for deduction of any expenses. In many cases, this can be a very expensive option. Under this option, you do not have to file a U.S. tax return to report this rental income. However, you will still need to report the net rental income on a Canadian tax return. Foreign tax credits can be taken to eliminate double taxation, but it is possible that the full 30% U.S. withholding tax will not be recouped.
OPTION 2 – Net rental basis
Alternatively, you can elect to file a U.S. non-resident income tax return (Form 1040-NR) on a net rental income basis and complete Schedule E. Net rental income is defined as gross rents less ordinary and usual expenses, including property taxes, mortgage interest, insurance, management fees, and utilities.
Note that, unlike in Canada, U.S. tax laws impose a mandatory deduction for depreciation for U.S. tax filing purposes. The benefit under this option is that your net rental income amount, subject to U.S. tax at your marginal tax rate, will likely be substantially lower than the gross rental income amount subject to the 30% withholding tax.
If you elect to file on a net rental basis, you will need to complete Form W-8ECI to avoid the 30% U.S. withholding tax. Form W-8ECI needs to be submitted to your tenant or to a U.S. agent (not to the IRS).
Net rental basis — Tax forms required and deadline
If you choose to be taxed based on the net rental basis option, then you will have to file a U.S. tax return and Schedule E by June 15 of the following year, even if the net rental calculation results in a rental loss. Regardless of the filing deadline, any balance of annual tax owing must be paid to the IRS by April 15 of the following year to avoid late interest charges.
If the June 15 deadline is missed, then there is an additional 16-month grace period to file a return on a net rental basis. Beyond the 16-month grace period, you will no longer be eligible to elect to pay on a net rental basis, and the 30% withholding tax on gross rental income (plus any penalties and interest) will apply for that tax year. For jointly held properties, each party is required to file a separate tax return and report their proportion of the rental income and expenses.
In addition to your U.S. tax filing obligations, you will also need to report on your Canadian tax return, in Canadian dollars, the net U.S. rental income/loss based on Canadian tax rules. In most cases, foreign tax credits taken on the Canadian tax return will alleviate potential double-taxation issues.