Helped along by the depressed US housing market in the past few years, the Palm Springs, California, area has become a hot spot for Canadians to purchase vacation homes or rental property. Often the same property is used for both purposes: vacations for snow-weary owners, and rentals when they go back to Canada. With the year about to end, it’s a good time to go over the basic tax rules for Canadians who own or rent real property in California.
Assuming the Canadian owner doesn’t have a green card or hold other residency status, the tax implications of owning real estate in the US will depend on how the property is used and how often it’s used.
If the property is solely used as a vacation home – and never rented out during the year – there should be no US tax implications until the house is transferred, either by sale, retitling into a trust or business entity, or at the owner’s death. In our wireless connected world, Canadians who mix vacation with work while at the property need to be careful about running afoul of US federal and California state income tax rules, especially when it comes to the very aggressive California tax authorities and their rules about California source income. But that’s another topic.
Actually, “never” is an overstatement. An owner of property can rent out the property for 14 days or less without tax reporting requirements, if the home is used personally for more than 14 days, or more than 10% of the total days it is rented to others. The amount of the rental income doesn’t matter in this case, so long as the use limits are met.
On the other end of the spectrum is real property never used for personal use, but rather rented out to others. The Canadian owner must report the entire rental income received on a US nonresident Federal and California tax return. At the same time, most rental owners qualify to deduct rental-related expenses: depreciation, utilities, repairs, property management fees, and the like. Further, rental losses may qualify for deductions against other income, at least in part, and may carry over for use in subsequent years. The ability to take loss deductions for 100% rental property distinguishes it from “mixed-use” property, which is a trickier tax situation.
Again, “never” is an exaggeration. The actual rule is if the personal use of a vacation home doesn’t exceed 14 days in a tax year or 10 percent of the total number of days it is rented out at fair market value, whichever is greater, and the property is rented out for more than 14 days, then it qualifies as a rental property.
More than a few Canadians are somewhere in the middle. They use their US property as a vacation home, but also rent it out for more than 14 days when they aren’t in the US. The rule is that if the owner uses the property for personal use for more than 14 days a year or, if greater, 10 percent of the number of days it is rented to others at fair market value, the property is treated as a residence, not a business. This is an important tax distinction. The owner must report all rental income on US tax returns and the rental expenses are usually deductible. But the expenses have to be allocated between the personal and rental use. More important, rental expenses in this scenario can be deducted up to the level of rental income, but the owner can’t use losses against other income.
A couple caveats. While the US and California have a “14-day” threshold, Canada does not. Therefore even de-minimus rental income may have to be reported in Canada. Further, resort towns like Palm Springs, Palm Desert, Rancho Mirage, Indian Wells, have additional municipal rules that restrict or otherwise regulate renting out vacation homes, including the imposition of fees. Finally, there are hefty state and federal withholding requirements for rent paid to non-US residents (though with private renters where there is no management company, those rules are often ignored). With proper planning, the withholding can be waived. Otherwise, the owner will have to file for a refund if the actual amount of taxes due on rental income totals less than the withheld amount.
Finally, note that in all these situations, how title to the property is held matters for tax purposes. If, for instance, the property is vested in both names of a married couple, then both must file US federal and California returns. If only one of the spouses is on title, only that spouse must file the returns (assuming no other income requiring the other spouse to file US returns). If the property is held in a revocable trust, then the grantor of the trust (that is, the person who established it) must file the returns. This may have important tax implications that should be considered at the time the property is purchased and title taken.