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Canadians Owning US Assets: How US Taxpayer ID Numbers Work

We are asked constantly by Canadians why they have to go through the pure drudgery of getting a US taxpayer ID number. And apparently, drudgery is absolutely the correct word as now the IRS wants to review either your actual passport, which is the best stand alone document you can provide (which means it may be out of your possession in the hands of the IRS for a few weeks), or a combination of a series of additional documents. We’ll talk in our next blog post about how you actually get the taxpayer ID number (via the Form W-7). But why does the Canadian snowbird need to get it? The answer is simple- it will cost you money if you don’t.

You will Need A Taxpayer ID Number to Avoid Mandatory 30% Withholding When You Rent Your US Property.

Without a taxpayer ID number, the Canadian Snowbird who rents US real estate must have the tenant or property manager withhold 30% of gross rent payments (and forward these amounts to the IRS). If the tenant or prop manager fails to withhold, the IRS will look to the Canadian for the withholding tax. However, if the Canadian snowbird completes a Form W-8ECI withholding certificate (which requires a US taxpayer ID number to get) and gives it to the tenant or property manger instructing them not to withhold, and then files the Form 1040NR tax return by June 15 of the next year, no withholding is required. This is a great option for the Canadian snowbird because it: (A) Allows the taking of deductions (e.g., property taxes, mortgage interest and depreciation) and (B) the tax rate is likely lower, much lower, than 30%.

Example. Snowbirds Suzy & Jeff purchase a house in Rancho Mirage. They personally use the house 2 months a year, and they rent it for $3,000 a month for the other 10 months. Before US taxes, Suzy & Jeff will receive $30,000 in rental income per year. What about after US taxes?

Option 1: They don’t go get a US taxpayer ID number. Tenant or property manager must withhold $900 a month from rent payments ($9,000 total for the year). Suzy & Jeff receive $21,000 per year after US taxes paid.

Option 2: First, Suzy & Jeff get a US taxpayer ID number and then complete a Form W-8ECI and then give it to the tenant or property manager and file a Form 1040NR tax return the next year. The tenant or property manager now knows he shouldn’t withhold. Suzy & Jeff deduct $400 of monthly interest from their mortgage and $200 of monthly property taxes. Their taxable US rental income for the year is $24,000. On $24,000, the US income tax rate is approximately 15% and the tax is approximately $3,600 (leaving Suzy & Jeff $26,400 for the year after US taxes paid).

You will Need A Taxpayer ID Number to Avoid Mandatory 10% Withholding on Your Gross Sales Price When You Sell Your US Property.

A similar rule exists in the sale of a house area, where, if the Canadian snowbird does not get a taxpayer ID number, the purchaser must withhold 10% and forward it directly to the IRS.

Example. Suzy & Jeff purchase a La Quinta house in 2009 for $800,000. In 2012, they sell the house to buyer for $1,000,000.

Option 1: No action taken. Buyer must withhold $100,000 for IRS (10% of the $1,000,000 sales price). Suzy & Jeff receive $900,000 after federal taxes withheld.

Option 2: Prior to the sale, Suzy & Jeff get a taxpayer ID number and then file an IRS Form 8288-B. Buyer must now only withhold $30,000 for IRS ($200,000 appreciation x 15% capital gains rate in 2012). Suzy & Jeff receive $970,000 after U.S. taxes paid.

So, unfortunately Canadians in the US, you really do have to face the drudgery of getting a taxpayer ID number.

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Sanger & Manes offers world class expertise in estate planning and tax management for international clients who own US assets, with an emphasis on Canadians purchasing vacation homes. Learn more at our website: www.calresidencytaxattorney.com.