US Taxpayers and the Principal-Residence Exemption
In most cases, the principal-residence exemption (PRE) will completely
eliminate the capital gain for Canadian tax purposes arising on the
disposition of a taxpayer’s home in Canada. However, US taxpayers (US
citizens, green-card holders, and US residents) are taxable on their
world income, and the analogous provision to the PRE under the Internal
Revenue Code is more restrictive. Therefore, a US taxpayer may incur a
US tax liability on the sale of a Canadian home that cannot be fully
offset on the US return with a foreign tax credit (FTC).
Consider a single US taxpayer residing in Canada who incurs a capital
gain of $750,000 (all figures in this article are in US dollars) on the
sale of her principal residence. There is no Canadian tax liability on
the sale, but for US tax purposes there is a $250,000 limit on the
amount of the capital gain that can qualify for exclusion (IRC section
121). The US tax liability is approximately $119,000 ($750,000 −
$250,000 exclusion × 23.8%, the top US personal income tax rate on
long-term capital gains). The liability will be less for married
taxpayers who file a joint US income tax return; the exclusion is
$500,000 in that case.
The issue is whether this liability can be offset by the FTC on the US
return. The sale of the principal residence attracts no Canadian tax, so
no FTC can arise from that income. Excess FTC might arise from the
taxpayer’s other income, since the Canadian tax on that other income is
probably higher than the similar US tax. However, gains on homes can be
large relative to other income in the year, and thus the US tax on that
gain may not be fully sheltered by a US FTC.
A second problem is that the gain on the Canadian home may not qualify
for any US exclusion at all. In the five years leading up to the
disposition, the taxpayer must have both owned and resided in the home
for at least 24 months (not necessarily the same months) (IRC section
121). A taxpayer who has owned the home for less than two years fails
the ownership test, and a taxpayer whose child was the occupant (rather
than the taxpayer) fails the use test. The PRE is available in both of
The capital gains on the Canadian home for US purposes can be reduced by
increases in the basis in the property—for example, the cost of a
fence, a new roof, new siding, built-in appliances, and flooring and
carpeting (see “Selling Your Home,” IRS Publication 523). Therefore, US
taxpayers should keep all receipts for improvements and for certain
repairs in order to reduce the future capital gain on disposition.
Further planning to mitigate US tax exposure may be available for
spouses if one spouse is a US taxpayer and the other spouse is taxable
only in Canada. In that case, a couple can consider an ownership
structure in which the Canadian taxpayer holds title to the property.
This is a practical solution when a property is first acquired; however,
it may not be practical if the property is already jointly owned. A
gift of the US taxpayer’s share in the property to the Canadian taxpayer
is problematic because US gift tax may apply.
Mowbrey Gil LLP, Edmonton