I was talking to an investor friend of mine who owns 2 houses in Atlanta, GA, and is looking to sell them to maybe buy a multiplex somewhere else in the US.
I was then reminded of the "1031 exchange" - rule that can be found under § 1031 of the US Internal Revenue Code (the “IRC”), which allows you to roll over the capital gain into the next property you will be purchasing.
According to Ronald S. Webster, the capital gain taxes can be eliminated in one of 2 ways:
- the property owner moves into one of the investment properties, declares it to be their primary residence, is married and has held the property for five years and resides in the property for a minimum of two years, they can then exempt $500,000.00 in taxes upon the ultimate sale.
- death of the property owner - heirs receive a step up in basis on the date of death.
There are 7 rules to observe:
1. like-kind property - i.e. old property as well as the new property, must be held for investment or utilized in a trade or business
2. 45 notification period
3. 180 day purchase period
4. use of a qualified intermediary
5. title must be miror image
6. reinvest equal or greater amount
7. title for both properties cannot be in the same name at the same time.
Now the question is: does it apply to Canadians invested in the US? This is what the article by Kenneth Keung explains: "A Canadian individual who owns rental property in the US is entitled to non-recognition treatment under § 1031 if another property is purchased within six months after the sale of the initial property and all other requirements under § 1031 are met. However, section 44 and subsection 13(4) of the Act will not apply because the property sold is a rental property. As such, the Canadian individual will recognize any capital gain and depreciation recapture in the year of the sale for Canadian tax purposes." Since the US tax doesn't apply on the sale, the Canadian taxpayer will be paying the full Canadian tax and when they end up selling the property ultimately, they will be paying the US taxes, which means double taxation.
"The same mismatch occurs even if the Canadian individual owns the US rental property indirectly through a corporation. If the holding corporation is resident in Canada for tax purposes, an IRC § 1031 Exchange will cause the corporation to recognize a capital gain immediately for Canadian tax purposes. The corporation will not be entitled to any foreign tax credits to offset against the Canadian tax on the gain because no US tax will be payable in the year of the exchange. On the other hand, if the holding corporation is resident in the US and it relies on IRC § 1031 to defer US tax on a sale, the Canadian individual will be deemed by virtue of the “foreign accrual property income” regime in subsection 91(1) of the Act to have received an imputed capital gain in the year of the exchange, as if the property were held personally. This leads to the same max credit to the Canadian individual as described and US rules is a frequent trap for the unwary. However, with careful planning such traps can be avoided."
Is there the same in Canada?
This is the information I found in this article: taxpayers may defer and roll capital gains into replacement properties under either section 44 or 44.1 of the Act.
" In Canada, taxpayers may defer and roll capital gains into replacement properties under either section 44 or 44.1 of the Act. Section 44 applies to a property that: (i) Has been stolen, destroyed, or expropriated (often referred to as an “involuntary disposition”),or (ii) Was real estate used by the taxpayer (or a related person) primarily for earning income from a business, but rental property (and any land subjacent to the rental property or land that is contiguous to the rental property that is a driveway, yard, parking area, garden or that is otherwise necessary for the use of the rental property) is specifically excluded. This subset of property is specifically defined as a “former business property” under subsection 248(1) of the Act. The seller must, within a specified timeframe, acquire a “replacement property”, which, generally speaking, is a property that replaces the former property and that is of same or similar use (see subsection 44(5) of the Act for further detail). If all conditions are met, the seller can elect to defer the gain realized on the former property by reducing the tax cost of the replacement property by such amount. Section 44.1 works in a similar manner, but is limited only to certain Canadian private corporation shares where all or substantially all of the assets of the corporation are used principally in active business and where the total carrying value of the assets of the related group of corporations is less than $50,000,000. There are also subsections 13(4) and 14(6), which provide parallel deferral rules for recapture income in respect of depreciable property and eligible capital property. Compared to IRC § 1031, the circumstances where the Canadian replacement property rules would provide for deferral are very narrow. A Canadian who sells rental property, wherever situated, will not be entitled to defer any gain merely because a replacement rental property is purchased with the sale proceeds, but the same transaction performed by a US taxpayer would qualify as a § 1031 Exchange. This would be the case even if the Canadian is in the business of renting property (see Buonincontri v. Queen, 85 D.T.C. 5277), or if the property is used for both business and rental but more than half of the space is devoted to the latter (see Grove Acceptance Ltd. v R., 2002 D.T.C. 2172). The Livingston case we referred to earlier is another example of the Court taking a narrow interpretation of section 44, finding that a replacement property must be a “direct substitution” of, and “the same species” as, the former property."
I was then reminded of the "1031 exchange" - rule that can be found under § 1031 of the US Internal Revenue Code (the “IRC”), which allows you to roll over the capital gain into the next property you will be purchasing.
According to Ronald S. Webster, the capital gain taxes can be eliminated in one of 2 ways:
- the property owner moves into one of the investment properties, declares it to be their primary residence, is married and has held the property for five years and resides in the property for a minimum of two years, they can then exempt $500,000.00 in taxes upon the ultimate sale.
- death of the property owner - heirs receive a step up in basis on the date of death.
There are 7 rules to observe:
1. like-kind property - i.e. old property as well as the new property, must be held for investment or utilized in a trade or business
2. 45 notification period
3. 180 day purchase period
4. use of a qualified intermediary
5. title must be miror image
6. reinvest equal or greater amount
7. title for both properties cannot be in the same name at the same time.
Now the question is: does it apply to Canadians invested in the US? This is what the article by Kenneth Keung explains: "A Canadian individual who owns rental property in the US is entitled to non-recognition treatment under § 1031 if another property is purchased within six months after the sale of the initial property and all other requirements under § 1031 are met. However, section 44 and subsection 13(4) of the Act will not apply because the property sold is a rental property. As such, the Canadian individual will recognize any capital gain and depreciation recapture in the year of the sale for Canadian tax purposes." Since the US tax doesn't apply on the sale, the Canadian taxpayer will be paying the full Canadian tax and when they end up selling the property ultimately, they will be paying the US taxes, which means double taxation.
"The same mismatch occurs even if the Canadian individual owns the US rental property indirectly through a corporation. If the holding corporation is resident in Canada for tax purposes, an IRC § 1031 Exchange will cause the corporation to recognize a capital gain immediately for Canadian tax purposes. The corporation will not be entitled to any foreign tax credits to offset against the Canadian tax on the gain because no US tax will be payable in the year of the exchange. On the other hand, if the holding corporation is resident in the US and it relies on IRC § 1031 to defer US tax on a sale, the Canadian individual will be deemed by virtue of the “foreign accrual property income” regime in subsection 91(1) of the Act to have received an imputed capital gain in the year of the exchange, as if the property were held personally. This leads to the same max credit to the Canadian individual as described and US rules is a frequent trap for the unwary. However, with careful planning such traps can be avoided."
Is there the same in Canada?
This is the information I found in this article: taxpayers may defer and roll capital gains into replacement properties under either section 44 or 44.1 of the Act.
" In Canada, taxpayers may defer and roll capital gains into replacement properties under either section 44 or 44.1 of the Act. Section 44 applies to a property that: (i) Has been stolen, destroyed, or expropriated (often referred to as an “involuntary disposition”),or (ii) Was real estate used by the taxpayer (or a related person) primarily for earning income from a business, but rental property (and any land subjacent to the rental property or land that is contiguous to the rental property that is a driveway, yard, parking area, garden or that is otherwise necessary for the use of the rental property) is specifically excluded. This subset of property is specifically defined as a “former business property” under subsection 248(1) of the Act. The seller must, within a specified timeframe, acquire a “replacement property”, which, generally speaking, is a property that replaces the former property and that is of same or similar use (see subsection 44(5) of the Act for further detail). If all conditions are met, the seller can elect to defer the gain realized on the former property by reducing the tax cost of the replacement property by such amount. Section 44.1 works in a similar manner, but is limited only to certain Canadian private corporation shares where all or substantially all of the assets of the corporation are used principally in active business and where the total carrying value of the assets of the related group of corporations is less than $50,000,000. There are also subsections 13(4) and 14(6), which provide parallel deferral rules for recapture income in respect of depreciable property and eligible capital property. Compared to IRC § 1031, the circumstances where the Canadian replacement property rules would provide for deferral are very narrow. A Canadian who sells rental property, wherever situated, will not be entitled to defer any gain merely because a replacement rental property is purchased with the sale proceeds, but the same transaction performed by a US taxpayer would qualify as a § 1031 Exchange. This would be the case even if the Canadian is in the business of renting property (see Buonincontri v. Queen, 85 D.T.C. 5277), or if the property is used for both business and rental but more than half of the space is devoted to the latter (see Grove Acceptance Ltd. v R., 2002 D.T.C. 2172). The Livingston case we referred to earlier is another example of the Court taking a narrow interpretation of section 44, finding that a replacement property must be a “direct substitution” of, and “the same species” as, the former property."
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