Archive for year: 2011

RE:  Tax Issues Canadians Owning Rental Property in US

Monday, November 14, 2011

 

1.0 Summary.  As a Canadian owning rental property in Nevada you will have to file income taxes in the United States.  The type of return you file depends on the number of days you spend in the U.S. and your other connections to the U.S. compared to Canada.   Generally, the U.S. only taxes you on the source income from the rental and at the rates U.S. citizens are subject to.  You will be able to take a credit for the U.S. taxes paid on your Canadian tax return.  However, if you don’t file form 1040NR and make an election to treat the income as effectively related to a business then you will be taxed a flat rate of 30% on your gross rental income without a deduction for expenses.

 

1.1 Canadian Income Tax Rules.  You will have to claim the income received from your U.S. rental property on your Canadian tax return.  You must report all income from sources received inside and outside Canada for the year.   You can receive a foreign tax credit for taxes paid to the IRS.  For more information on reporting foreign income on your return see the CRA’s General Income Tax and Benefit Guide form 5000-G.  You must also complete Form T1248, Information About Your Residency Status (Schedule D), and attach it to your Canadian return.

 

1.2 United States Income Tax Rules.  The US income tax rules for Canadians depends on whether you qualify for the resident alien or non-resident alien status.  The IRS uses the substantial presence test to determine if you are a resident alien or a non-resident alien of the U.S. for tax purposes.

 

1.3 Substantial Presence Test.  This test uses the number of days you were in the U.S. during a three-year period (the current and the two previous years) to determine if you are a resident alien or a non-resident alien.  If you spend more than 30 days in the U.S. during the year the IRS might consider you a resident alien.  There are several factors and exceptions to the substantial presence test please seek tax advice for determining your status.  Even if the substantial presence test determines you are a resident alien you can file form 8840 with the IRS claiming you have more connections with Canada and therefore should not be considered a resident alien.

 

1.4 Resident Alien Status US Tax Consequences.  Resident aliens have to file a U.S. tax return to report income from all sources inside and outside the U.S. for the year.  You will file as a resident alien and report all income including your rental income on IRS form 1040.

 

1.5 Non-Resident Alien Status U.S. Income Tax Consequences.  Non-Resident Aliens only report U.S. source income on their U.S. income tax returns.  As a non-resident alien, you are subject to U.S. income tax on rental income you receive from U.S. real property.

 

1.6 Effectively Connected v. Not-Effectively Connected.  The IRS divides your income into two categories:  1) Effectively connected with a trade or business and 2) not effectively connected with a trade or business.  Rental income is not effectively connected with the conduct of a U.S. trade or business.  However, you can elect to treat rental income as income that is effectively connected with the conduct of a U.S. trade or business by attaching a letter to Form 1040NR stating that you are making the election.

 

1.7 Income Effectively Connected.   Income that is effectively connected with a trade or business in the U.S. (including income from the sale or exchange of U.S. real property) is taxed at the same rates that apply to U.S. citizens and residents.  If you have filed the election your U.S. rental income will be treated as income effectively connected.

 

1.8 Income Not Effectively Connected.  Income that is not effectively connected with a trade or business in the U.S., but is from U.S. sources (including interest, dividends, rents, and annuities) is taxed at 30% of gross income.  If you do not make the election to treat your rental property as effectively connected your property manager should withhold 30% of your gross income from your rental. 

 

1.9 Further Information.  For more information regarding income taxes for Canadians owning rental properties in the U.S.  see the following publications:

 

• IRS Publication 515 Withholding of Tax on Nonresident Aliens and Foreign Entity:  http://www.irs.gov/pub/irs-pdf/p515.pdf

 

• IRS Publication 519 Tax Guide for Alien:  http://www.irs.gov/pub/irs-pdf/p519.pdf

 

• IRS Publication 527 Residential Rental Property:  http://www.irs.gov/pub/irs-pdf/p527.pdf

 

• CRA Publication Canadian Residents Going South:  http://www.cra-arc.gc.ca/E/pub/tg/p151/README.html

 

• CRA Publication General Income Tax and Benefit:  http://www.cra-arc.gc.ca/E/pub/tg/5000-g/README.html

 

IRS Circular 230 Notice: To ensure compliance with requirements now imposed by the Internal Revenue Service of the U.S. Treasury Department, we are hereby informing you that any federal tax advice contained or perceived contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code; or (ii) promoting, marketing or recommending to another party any transaction or matter addressed in this communication. 

 

 

 

1.  Hiding Income Offshore

The IRS aggressively pursues taxpayers involved in abusive offshore transactions as well as the promoters, professionals and others who facilitate or enable these schemes. Taxpayers have tried to avoid or evade U.S. income tax by hiding income in offshore banks, brokerage accounts or through the use of nominee entities. Taxpayers also evade taxes by using offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, private annuities or insurance plans.

In early February, the IRS announced a special voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes. The new voluntary disclosure initiative will be available through Aug. 31, 2011. The IRS decision to open a second special disclosure initiative follows continuing interest from taxpayers with foreign accounts. In response to numerous requests, information about this initiative is available on IRS.gov in eight different languages, including: Chinese, Farsi, German, Hindi, Korean, Russian, Spanish, and Vietnamese.

2.  Identity Theft and Phishing

Identity theft occurs when someone uses an unsuspecting individual’s name, Social Security number, credit card number or other personal information without permission to commit fraud or other crimes. For example, a criminal can use someone else’s information to run up bills on that person’s credit card, empty that person’s bank account or take out a loan in that person’s name. And when it comes to taxes, a criminal with someone else’s personal information can file a fraudulent tax return and collect a refund.

Phishing is one tactic used by scam artists to trick unsuspecting victims into revealing personal or financial information online. Phishing involves the use of phony e-mail or websites — even social media. A scammer may pose as an institution such as the IRS. IRS impersonation schemes flourish during tax season. Spyware, which can be loaded onto an unsuspecting taxpayer’s computer by opening an e-mail attachment or clicking on a link, is another tool identity thieves use to steal personal information.

Identity theft is a major problem that affects many people each year. That’s why it’s important that taxpayers protect their personal information. Anyone who believes his or her personal information has been stolen and used for tax purposes should immediately contact the IRS Identity Protection Specialized Unit at 1-800-908-4490. A suspicious e-mail or an “IRS” Web address that does not begin withhttp://www.irs.gov should be forwarded to the IRS at phishing@irs.gov.

3.  Return Preparer Fraud

While most return preparers are professionals who provide honest and excellent service to their clients, some make basic errors or engage in fraud and other illegal activities.

Dishonest return preparers can cause big trouble for taxpayers who fall victim to their ploys. These fraudsters derive benefit by skimming a portion of their clients’ refunds, charging inflated fees for return preparation services and attracting new clients by making false promises. Taxpayers should choose carefully when hiring a tax preparer. Federal courts have issued hundreds of injunctions ordering individuals to cease preparing returns, and the Department of Justice has pending complaints against dozens of others.

To increase confidence in the tax system and improve compliance with the tax law, the IRS is implementing a number of requirements for paid tax preparers, including registration with the IRS and a preparer tax identification number (PTIN), as well as competency tests and ongoing continuing professional education.

The new regulations require paid tax preparers (including attorneys, CPAs, and enrolled agents) to apply for a Preparer Tax Identification Number (PTIN) before preparing any federal tax returns in 2011.

Higher standards for the tax preparer community will result in greater compliance with tax laws, increase confidence in the tax system and ultimately lead to a better experience for taxpayers.

4.  Filing False or Misleading Forms

IRS personnel are seeing various instances in which scam artists file false or misleading returns to claim refunds to which they are not entitled. In one variation of this scheme, a taxpayer seeks a refund by fabricating an information return and falsely claiming the corresponding amount as withholding. Phony information returns, such as a Form 1099 Original Issue Discount (OID), which claims false withholding credits, are usually used to legitimize erroneous refund claims. One version of the scheme is based on the bogus theory that the federal government maintains secret accounts for its citizens and that taxpayers can gain access to funds in those accounts by issuing 1099-OID forms to their creditors, including the IRS.

The IRS continues to see instances in which people file false or fraudulent tax returns to try to obtain improper tax refunds. The IRS takes refund fraud seriously, has programs to aggressively combat it and stops the vast majority of incorrect refunds.

Because scammers often use information from family or friends in filing false or fraudulent returns, beware of requests for such data. Don’t fall prey to people who encourage you to claim deductions or credits you are not entitled to or willingly allow others to use your information to file false returns. If you are a party to such schemes, you could be liable for financial penalties or even face criminal prosecution.

5.  Frivolous Arguments

Promoters of frivolous schemes encourage people to make unreasonable and outlandish claims to avoid paying the taxes they owe. The IRS has a list of frivolous legal positions that taxpayers should avoid. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law or IRS guidance.

6.  Nontaxable Social Security Benefits with Exaggerated Withholding Credit

The IRS has identified returns where taxpayers report nontaxable Social Security Benefits with excessive withholding. This tactic results in no income reported to the IRS on the tax return. Often both the withholding amount and the reported income are incorrect. Taxpayers should avoid making these mistakes. Filings of this type of return may result in a $5,000 penalty.

7.  Abuse of Charitable Organizations and Deductions

The IRS continues to observe the misuse of tax-exempt organizations. Abuse includes arrangements to improperly shield income or assets from taxation and attempts by donors to maintain control over donated assets or income from donated property. The IRS also continues to investigate various schemes involving the donation of non-cash assets including situations where several organizations claim the full value for both the receipt and distribution of the same non-cash contribution. Often these donations are highly overvalued or the organization receiving the donation promises that the donor can repurchase the items later at a price set by the donor. The Pension Protection Act of 2006 imposed increased penalties for inaccurate appraisals and set new definitions of qualified appraisals and qualified appraisers for taxpayers claiming charitable contributions.

8.  Abusive Retirement Plans

The IRS continues to find abuses in retirement plan arrangements, including Roth Individual Retirement Arrangements (IRAs). The IRS is looking for transactions that taxpayers use to avoid the limits on contributions to IRAs, as well as transactions that are not properly reported as early distributions. Taxpayers should be wary of advisers who encourage them to shift appreciated assets at less than fair market value into IRAs or companies owned by their IRAs to circumvent annual contribution limits. Other variations have included the use of limited liability companies to engage in activity that is considered prohibited.

9.  Disguised Corporate Ownership

Corporations and other entities are formed and operated in certain states for the purpose of disguising the ownership of the business or financial activity by means such as improperly using a third party to request an employer identification number.

Such entities can be used to facilitate underreporting of income, fictitious deductions, non-filing of tax returns, participating in listed transactions, money laundering, financial crimes and even terrorist financing. The IRS is working with state authorities to identify these entities and to bring the owners of these entities into compliance with the law.

10.  Zero Wages

Filing a phony wage-or-income-related informational return to replace a legitimate information return has been used as an illegal method to lower the amount of taxes owed. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.

Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any of the variations of this scheme. Filings of this type of return may result in a $5,000 penalty.

 

Information from the IRS Newswire