Tax troubles when moving to the U.S.

Rajesh and his wife are moving to the U.S. What are the tax implications of their rental property in Canada and their TFSAs?

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Q: My wife moved to the U.S. for work last year and I am in the process of moving next week.

Following are the questions we have:

We have rented our house in Canada and we are renting an apartment in the U.S. (California). Since housing is very expensive in California, we will rent for a while before we decide to buy. When we decide to buy we will sell the house in Canada and use the funds for a down payment towards the home purchase in the U.S. In this situation, what do I need to be aware of from a tax implication standpoint such as capital gains taxes and others.

Just recently, I topped up my TFSA account in time before my move. This did not happen with my wife. What options does she have now to contribute towards a TFSA (she has lots of room) given she is not a resident for tax purposes?

Rajesh

A: Generally, Rajesh, when real estate changes from personal use to a rental or from a rental to personal use, there is a deemed disposition for capital gains tax purposes. It’s as if the property was sold and immediately reacquired at the fair market value.

In the case of a primary residence being converted to a rental property, this means that the fair market value becomes the adjusted cost base for capital gains purposes and the tax clock starts ticking so to speak.

There is an exemption called a subsection 45(2) election that allows you to designate a principal residence as such for an additional four years after moving out if you or your spouse has to relocate for work, but the move has to be within Canada.

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Leaving Canada generally results in a deemed disposition of all capital property like real estate regardless, so your departure from Canada and change in use of your principal residence both result in the deemed disposition of your home and the immediate reacquisition at fair market value in this case, Rajesh.

If neither of you has declared any other real estate as your principal residence during the time you have owned your home, it would generally qualify as your principal residence with no capital gains tax payable on the change in use or departure from Canada (which effectively occurred simultaneously).

When you either sell your home or move back in (this would change the use from rental back to principal residence), you will have another disposition for tax purposes and the capital gain from now until that point would be taxable. This would be the case even if you were a non-resident when the sale took place, Rajesh, as Canada taxes non-residents on real estate transactions.

As for the TFSA, I think your wife’s options with her TFSA depend on the facts. It may be that despite her departure from Canada, she is still technically a resident of Canada for tax purposes until you leave as well. Having family in Canada is a primary tie to the country that may mean she has still not truly given up residency in a tax sense until you move.

If this is the case, she may still be able to contribute to her TFSA, Rajesh.

That said, the U.S. IRS does not formally recognize Canadian TFSAs as a tax-free account (they do recognize the tax-deferred status of RRSPs). While I know some U.S. CPAs who have taken the position that TFSAs are tax-free in the U.S. based on their resemblance to U.S. Roth IRAs, the vast majority feel they are subject to U.S. taxation and until the IRS clarifies this, you have to consider the possibility your TFSA may be taxable in the U.S. anyway.

Investment options may exist that result in no taxable distributions being made in your TFSA. This might be worth considering in case: a) the U.S. specifically exempts TFSAs from Canadian taxation in the future; b) you return to Canada and can grow your TFSA and resulting tax-free investment room in your TFSA in the meantime.

Regardless, Rajesh, you should seek advice from a U.S. CPA familiar with cross-border taxation, particularly this year given your dual status in Canada and the U.S.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.


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2 comments on “Tax troubles when moving to the U.S.

  1. Well I did understand the problem. Here my suggestion is you should contact one of our Toronto Tax Lawyer from Taxpage.com, even you can get telephonic consultancy also.

    Reply

  2. And don’t forget to file FBARs (FinCEN Report 114) for the TFSA and all those other “foreign accounts”. If you don’t know about this, do yourself a favour and look it up.

    And, yes, nearly all cross-border tax specialists will say that the TFSA (and RESP, and RDSP) is not a tax-free account as far as the IRS is concerned. Not only that, but it is arguably a “foreign” trust (RESP and RDSP are definitely) and so requires filing of forms 3520 and 3520A.

    If you’re thinking of ignoring this, consider the associated penalties – look them up, they’re not pretty.

    Reply

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