— Patricia Moon (@nobledreamer16) July 7, 2014
It is believed that at least one million Canadian citizens may be considered under U.S. law to also be U.S. citizens. The Obama administration has passed a new U.S. law, that the Government of Canada (AKA Harper Government) has agreed to implement on Canadian soil. The law called “FATCA” (Foreign Account Tax Compliance Act) basically requires the Canadian banks to:
1. Identify Canadians who may be considered by the U.S. to be U.S. citizens; and
2. Turn them over to Canada’s CRA, which will then turn them over to the IRS.
Toronto real estate agents take note! This new law will affect your clients and impose a new duty of care when advising these clients!
When I first heard about this, I thought it must be pure fantasy. Actually, FATCA took effect in Canada – on Canada Day – July 1, 2014. The problem of having U.S. citizenship is that the United States follows its citizens all over the world attempting to collect taxes from them. For further explanation of the U.S. taxation of Canadian citizens, see a recent article by Rubina in ratesupermarket.ca.
The article includes:
The United States employs a method known as worldwide taxation, meaning U.S. persons (citizens, green card holders and long-time residents) must declare all income received annually from anywhere in the world to the IRS, or risk being in breach of tax compliance laws. This applies even to persons who don’t live and work in the U.S., such as those who inherit dual citizenship from their parents. Eretria is the only other country in the world that uses this practice.
Incredibly, the IRS wants a cut of all income earned in Canada and a portion of the Capital Gain on the sale of your principal residence! Now, you become a U.S. citizen if you were born in the U.S. Think of all those unlucky people who were born in the United States. The tax free capital gain on the principal residence is one of many tax advantages that one loses if one was born on the wrong side of the border.
The way this works was explained at the Isaac Brock Society blog as follows:
U.S. citizens absolutely should NEVER be an executor. At a minimum, it will invite a visit from Mr. FBAR.
On the issue of the sale of the principal residence, here is how it works.
So, let’s imagine a principal residence that is owned by a U.S. Citizen abroad and spouse. I will run the example with a U.S. citizen spouse and then with a non-U.S. citizen spouse.
In order to understand this example, you must understand the following rules:
1. In the U.S. the sale of a principal residence does NOT result in a tax free capital gain. In fact is is a taxable capital gain with the first $250,000 exempt from capital gains tax. A capital gain is defined as the difference between the sale price and the purchase price. This full amount less $250,000 will be taxable.
2. The purchase price must be calculated in U.S. dollars at the exchange rate on the date of purchase. The sale price must be converted to U.S. dollars at the exchange rate on the date of purchase.
3. The discharge of any mortgage must be taken account. For example if you borrow $100,000 Canadian dollars and repay $100,000 Canadian dollars, the U.S. dollar equivalent of the mortgage must be calculated. Bottom line: if you pay back less than you borrowed in USD, then you would have a taxable gain. I tried to explain in the following post:
4. The new Obamacare 3.8% tax (which is not creditable) must also be paid.
5. If the house were owned by two U.S. citizen spouses, who were filing jointly, then the exemption would be $250,000 times two – $500,000.
6. If the house were owned by a U.S. citizen and an “alien” spouse, then there would be only one $250,000 exemption. Furthermore, (assuming the U.S. citizen spouse was filing in the “married filing separately status”) then the Obamacare surtax would be higher. (Marriages between a U.S. citizen and a non-citizen are presumed to be a form of tax evasion).
Example 1 – Two U.S. citizen spouses
Okay, now let’s run a very realistic example. Let’s say that Charles Citizen marries Candance Citizen and they buy a house in Vancouver in 1984 for $300,000. Let’s say that the house is sold in 2014 for $2,300,000. Let’s say they are both filing U.S. taxes and their filing status if “married filing jointly”. Let’s say the house was financed with a $200,000 secured loan that they paid interest on for 30 years.
Assume the following exchange rates:
1984 – 1 USD = 2 Cdn dollars
2014 – 1 USD = 1 Cdn dollar
1984 Conversions to USD
The 1984 purchase price of the house was $150,000 USD and the amount borrowed was $100,000 USD
2014 Conversions to USD
The sale price of the house was $2,300,000 USD and the amount paid back was $200,000.
So, here is how I think it would work:
A. Calculate the capital gain:
1. Capital gain is $2,300,000 less $150,000 or $2,150,000. But because they are both U.S. citizens and they are filing jointly, they will get a $500,000 capital gain exemption. Therefore, the taxable capital gain will be $1,650,000. (Note how the exchange rate problem increases the gain.)
So, $1650,000 will be included in their income and they will pay tax on that at the appropriate (I assume long term capital gain rate of 20%).
So, 20% of 1,650,000 is $330,000. Now let’s add the Obamcare surtax which is harder to calculate because it’s based on a different definition of income. But, 3.8% applied to the whole gain would be another $62,700 (but it will be less). You get my point. That puts the taxable U.S. gain up to about $400,000.
If you look at this article there are possible ways to get it down:
B. The Foreign Exchange Problem
Now on too the foreign exchange problem. You borrowed $100,000 USD and paid back $200,000 USD. In other words, you paid back more than you borrowed. Can this loss be used to offset the gain? In other words, are these treated as separate transactions or as all part of the same transaction?
Anyway, the number are unlikely to come out as badly as this. But, the point is that for U.S. citizens in Canada, the principal residence is simply NOT a tax free capital gain. This makes it difficult for U.S. citizens to be upwardly mobile in the housing market and difficult for them to plan for retirement.
Example 2 – U.S. Citizen married to an alien when the alien owns half the house. (Charles Citizen marries Anne Alien).
Same numbers but cut everything in half. The Obamacare surtax will kick in at a lower level and will therefore be proportionately higher.)
Note in this case that the non-citizen spouse pays a huge penalty for being married to a U.S. person! The U.S. person has a benefit (in this case) for having an alien spouse.
Interestingly, there has been a lot of talk lately about the inflated real estate market. Are the prices too high to buy? Should people rent instead of buy? Interestingly the answer depends on largely on where you were born.
A. If you were born in the U.S. (and therefore a U.S. taxpayer), and therefore carry an “IRS discount”, the case for home ownership is NEVER as strong as for a non-U.S. person. For U.S. persons abroad a “tax free gain” simply does not exist.
B. But, what about the effect of this on Canada? What about the problem of leakage of Canadian capital to the U.S. through the “Trojan Horse” route. In the same way that the U.S. claims to need FATCA (per Richard Harvey) to protect the U.S. tax base, Canada must protect it’s tax base from U.S. persons.
What might this mean? Well, I can easily see Canadian laws changing to stipulate that U.S. persons CANNOT be permitted a tax free capital gain in Canada. Why should Canada allow a tax free gain if the result is that the U.S. citizen simply pays tax to the IRS. Therefore, I fully expect to see the Income Tax Act of Canada amended to follow the mandatory discrimination against U.S. citizens prescribed in Bill C-31 and:
Either prohibit U.S. citizens from owning a principal residence or deny them a a tax free capital gain on that residence. The same principle will be applied to most Canadian retirement planning vehicles. After all, Canada must protect its tax base.
Just wait and see. I don’t see any Country can afford the “U.S. Person Drain On It’s Economy”.
Sounds dismal doesn’t it.
As you can see, the fact of U.S. citizenship negatively affects investment returns in life, real estate, business and marriage.
So, what can a U.S. citizen abroad invest in without complication and where U.S. citizenship does not directly affect investment returns?
As far as I can see there are only two things:
1. Individual shares of stocks (but remember that if they are Canadian stocks the U.S. person will NOT get the benefit of the Dividend Tax Credit); and
2. A GIC.
How do you like your “freedom now”?
Footnote – I am sure that many of you wished you had known of this earlier. Make sure your children understand the risks of U.S. citizenship.
Pass on these thoughts:
— Landlord Relief (@LandlordRelief) July 8, 2014
Lately a number of financial reporters and bloggers (noting the “run up” in the Toronto real estate market) have been questioning whether one should own or rent.
— Rob Carrick (@rcarrick) June 10, 2014
— Landlord Relief (@LandlordRelief) July 8, 2014
It is clear that those born in the USA have far less to gain from an increase in the value of real estate. Therefore, arguments for renting instead of owning are magnified if the person is a U.S. citizen. Therefore, it makes less sense for U.S. citizens to “own their own home”.
But, that is jut the cost, of having been born in the “Land of the free”.
For Canadian citizens born in the USA, the theme should be:
“Go rent young man!”
For Toronto Real Estate Agents and Investment Advisers:
When describing a principal residence as a “tax free capital gain”, you better make sure that your client was NOT born in the USA or is NOT a U.S. citizen for another reason!
For Canadian citizens in general:
What do you think of the Government of Canada imposing a U.S. law on Canadian soil – a law specifically designed to surrender Canadian citizens to the U.S.?