August 6, 2020
The Canada Revenue Agency’s (CRA’s) audit programs continue to be updated. On June 25, 2020, the CRA announced one of its newest programs: they will now audit the US real estate transactions of Canadians, looking back as many as six years.
Property records in the US will be reviewed by CRA for any record of Canadian ownership. Information that will be verified includes municipal addresses, square footage, names of the owners, sales histories, and property tax assessments. This represents an extensive search of a foreign database in order to uncover taxable transactions involving Canadians. A very a rare step indeed, without a specific prior indication and in a specific case.
The exposure for Canadian taxpayers is also extensive:
Unreported Foreign Property
All Canadian residents are required to disclose their holdings of foreign income-producing assets when the aggregate amount of those assets exceeds CAD$100,000. Most real property will qualify.
This is true regardless of whether the owner is an individual, a corporation, or a trust: all three forms of ownership require this disclosure. CRA has communicated that they will be reviewing deeds and other evidence of ownership in US real estate transactions – it should be assumed that hiding ownership will be extremely difficult, if not impossible.
The penalties for not reporting ownership of foreign property are automatic and significant. The penalty is calculated at $25/day, to a maximum of $2,500 per instance. The penalty may increase to as much as 5% of the cost of the foreign property if more than 24 months have passed.
Unreported Rental Income
Airbnb, VRBO, and other online platforms make it extremely easy today to arrange the rental of property on the most casual of basis. It seems to be an easy way to make money casually renting your real estate. For Canadian residents, income from US real estate is taxable in Canada (as well as the United States), whether it is one rental day or 365.
The CRA will be looking into these activities in detail. Unreported rental activity that has taken place on any portal or posted online could be easy to verify by the Canadian tax authorities. Through the mutual assistance agreement in the Canada/US Tax Treaty, the CRA has the authority to request records from the IRS, verify if rental income was withheld by renting agents and remitted directly to the IRS, or request any returns that were filed with the IRS. The CRA also has the authority to review and deny deductions of rental expenditures, including the ability to make sweeping assumptions and assess tax when records are not available. Taxpayers are well-advised to get their records in order as soon as possible.
Unreported Property Sales
Thousands of Canadians and Americans change their residence between Canada and the US each year. In Canada, taxpayers receive an exemption for the sale of their principal residence. However, the sale must still be reported to the CRA, and there is a penalty of up to $8,000 for not reporting the disposition of a principal residence. Canadians moving from the US to Canada may have simply forgotten or did not know how to report the sale on their Canadian tax returns prior to taking up US residence.
Sales of non-principal residences are also on CRA’s radar. This could include transfers that may be often thought to be non-taxable, such as a “quitclaim” transfer. The quitclaim deed is a non-warranty deed used to transfer property interest without any guarantees. It is often used between related parties, or between owners and entities they control because the documentation required is minimal. In Canada, however, transfers between any related party, both individual or otherwise, are deemed to take place at fair market value. (Special elections are available for transfers between owners and entities). These transactions are taxable. This fact may not be appreciated by owners transferring property using a quitclaim deed.
Inadequate or Inappropriate Documentation
Many taxpayers enter into real estate transactions using alternative legal entities to hold the assets (i.e. trusts, bare trusts, partnerships, etc.) but fail to go through the formalities to document the transfer or purchase of the real estate by these legal entities. Either the entity has not filed the proper annual tax and information returns with the CRA, or perhaps the entity was never even constituted in the first place (i.e. registering title as a “trust” but not creating the Trust Agreement). Any of these pitfalls can spell big trouble when the transactions are audited. Income that taxpayers may have thought was sheltered from tax, or deferred, in fact, may not be. Title to property, which taxpayers thought was held by a particular entity or person, may in fact not be. Transfers, which owners thought had occurred, may not legally have occurred. Property may be exposed to creditors when in fact it was thought to be protected. This can be particularly problematic in cases where the original owner has died, or it is part of an estate plan. Years of overdue taxes, penalties, and interest could be the result.
Impacts – and what to Do?
With Canada’s very close ties to the United States, the number of Canadians purchasing real estate in the United States is bound to keep growing. Experts estimate that in 2018, Canadians purchased 27,400 properties, valued at USD$10.5B in total. The average purchase price is estimated to have been USD$383,900. In 2017, the number of homes was over 30,000, with an average price of over USD$500,000.
Any taxpayer with US real estate is advised to review their documentation. Ensure that you have properly documented title and beneficial ownership. Review your tax filings, in both Canada and the US. Review your holdings structure, ensure that all entities are properly documented and that a professional has commented on any estate tax implications.
This newest of CRA’s audit programs may be an effort that nets a great deal in unpaid taxes. The implications for Canadian holders of US real estate is clear: it is time to get your houses in order.
 https://www.canadatoarizona.com/canadians-buying-us-real-estate-in-2018/, accessed August 4, 2020.