Unsurprisingly, many Canadians invest south of the border – in both stocks and real estate. On the world stage, economically speaking, we are little potatoes.
As of May 31, 2021, Canada’s country weight is within the MSCI All Country World Index was below 3%. By comparison, US stocks made up nearly 58%.
The average Canadian home price was $ 695,657 in April 2021. In Canadian dollars, the average price of a US home was significantly cheaper at $ 535,194.
But before you dive into U.S. investing, know that Canadian and U.S. tax implications for a Canadian investor are to be considered.
Stocks and ETFs
If a non-resident invests in US stocks or US-listed Exchange Traded Funds (ETFs), the standard dividend withholding tax is 30%. A Canadian resident is entitled to a lower withholding tax rate of 15% under a treaty between the two countries when submitting a form W-8 BEN with the brokerage with whom they hold the assets.
The 15% withholding tax is generally the only tax liability a Canadian investor has on the Internal Revenue Service (IRS) unless you are a US citizen. (U.S. residents of Canada must file both U.S. tax returns and Canadian tax returns.)
If a Canadian resident who is not a US citizen sells a US stock or an ETF for a profit and makes a capital gain, he or she will not pay any tax to the US government on that profit.
Dividends, interest, capital gains and other capital gains
U.S. dividends, interest, capital gains, and other capital gains are taxable on a Canadian resident’s T1 tax return because Canadians pay tax on their worldwide income.
US interest income is generally not subject to withholding tax for a Canadian resident.
All US taxes withheld on other investment income are eligible for a foreign tax credit. This generally reduces the dollar-for-dollar Canadian tax otherwise payable and avoids double taxation.
U.S. dividends, interest, and capital gains must be reported in Canadian dollars based on the prevailing exchange rate. Most people use the annual average rate to convert their income to Canadian dollars, but it is also acceptable to use the rate on the day of the transaction.
Capital gains are a little more difficult than dividends and interest because you need to determine at least two exchange rates: the exchange rate on the day of purchase and the exchange rate on the day of sale. Because exchange rates fluctuate, it is possible that the shift in exchange rates in Canadian dollars could cause a very different capital gain or loss than the US dollar.
If an investor has bought shares at different times, the effort is even greater. You will need to determine the exchange rate for each Canadian dollar purchase to determine the adjusted cost base. This can be particularly challenging for someone who has a stock savings plan with a U.S. employer where, for example, they buy stocks with every paycheck.
Canada-listed ETFs and Canadian mutual funds that own US stocks are themselves considered Canadian residents, just like an individual taxpayer. They are subject to withholding tax before the Fund receives a dividend. This withholding tax is usually shown on a T3 receipt (sometimes also a T5 receipt depending on the fund) and can also be claimed for a foreign tax credit in Canada.
So far, these statements apply to unregistered, taxable investment accounts. There is a slightly different impact if a Canadian buys US stocks or ETFs in another account.
Registered investment accounts
Tax-free savings accounts (TFSAs), Registered education savings plans Disability Savings Plan (RESPs) and Registered Disability Savings Plans (RDSPs) generally have the same effect on withholding tax by the IRS as a taxable account. However, since these accounts are tax-exempt or tax-privileged, there are no tax implications for a Canadian beyond withholding tax.
Does this mean you shouldn’t own US stocks in a TFSA, RESP, or RDSP? No, but it does mean it comes at a low cost, albeit in favor of a more diversified investment portfolio.
A Registered retirement plan (RRSP) or a similar tax-privileged retirement savings account receives special treatment from the IRS. If you own US stocks or US-listed ETFs, there is usually no withholding tax. However, if you own a Canada-listed ETF or Canadian mutual fund that owns US stocks, the tax is withheld before it is credited to the fund or your RRSP.
For a Canadian taxpayer, the tax implications are the same whether you have an account in Canada or the United States. The physical location of the account doesn’t matter.
Canadians investing in US real estate have different effects depending on whether it is a property for personal use or a rental property.
Property for personal use generally has no annual tax filing requirements, while rental property must be reported each year in both Canada and the United States.
Rental income and expenses should be reported on both Canadian and US tax returns. A Canadian resident with a US rental property must have a 1040-NO Tax return to report US source income to the IRS. All US taxes payable are generally eligible as a foreign tax credit in Canada to reduce the Canadian tax otherwise payable.
There may be a gain or loss on a sale in Canada and the United States. Canadian profit or loss depends on the purchase price in Canadian dollars and the sale price in Canadian dollars, based on the exchange rates prevailing at the time of each transaction. Buying and selling costs as well as any renovations can reduce a capital gain (or increase a loss).
A Canadian is generally subject to 15% withholding tax on gross proceeds of U.S. real estate unless they apply for a withholding tax certificate prior to closing to reduce tax based on estimated capital gains. The US withholding tax paid can be used as a foreign tax credit in Canada.
If a Canadian taxpayer has more than $ 100,000 in overseas assets, including U.S. stocks, ETFs, rental real estate, or other investments, they must T1135 Confirmation of Foreign Income Form with your Canadian tax return. The $ 100,000 limit is the Canadian dollar cost of the investment. Foreign real estate for own use as well as tax-privileged RRSPs or tax-free TFSAs do not have to be reported.
These are just some of the basic tax implications for a Canadian investor who owns US assets. Investing in US stocks, ETFs, or real estate can help diversify a portfolio, but it also introduces additional complexity and tax compliance requirements.
Jason Heath is a Certified Financial Planner (CFP) with Objective Financial Partners Inc. in Toronto. He does not sell any financial products.
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