The Principal Residence Exemption (PRE) has long been a significant tax break for Canadians selling their homes, especially in markets across the country that have seen sharp increases in housing prices over the past few decades. In short, if certain residency requirements are met, the capital gain (regardless of the amount) arising from the sale of a home is exempt from taxation.
However, U.S. citizens, who are subject to U.S. tax rules with respect to their worldwide income, cannot avail themselves of the same PRE for U.S. tax purposes. Under certain circumstances, this can leave Americans living in Canada with an unexpected tax bill.
To identify the kinds of scenarios in which such U.S. tax would be due, it is perhaps easiest to understand the two primary provisions which mitigate the income inclusion and resulting tax.
$250,000/$500,000 exclusion
The IRS offers their own limited form of the PRE to exclude part of the capital gain from taxable income. If the prescribed eligibility test (which includes criteria similar to that of the PRE) is met, up to USD $250,000 of the capital gain is excluded. The exclusion amount doubles to USD $500,000 when a married couple that meets the eligibility test files a joint U.S. tax return.
Foreign tax credits
To the extent any capital gain from the sale remains, a foreign tax credit may be available to reduce or eliminate the U.S. tax thereon (which can reach as high as 20% for taxpayers in the top U.S. tax bracket). If Canadian tax is paid by the U.S. seller on investment income (for example, generated from assets not held in a registered account), it can be applied against both the U.S. tax owing on investment income and the residual capital gain from the sale of the home. Since Canadian tax rates (federal and provincial) tend to be higher than U.S. tax rates, a surplus of foreign tax credits are often generated and can be sufficient to cover the tax on both investment income and the home sale. Furthermore, the foreign tax credit carryover rules will generally allow for unused foreign tax credits from a different tax period to be applied against the U.S. tax owing in the year of the sale.
A special Net Investment Income Tax (NIIT) of 3.8% may apply to the unexcluded portion of the gain if taxable income exceeds a certain threshold. Unlike regular tax, NIIT cannot be reduced by foreign tax credits.
Who is at risk?
Given these provisions, the U.S. tax exposure will be worth considering for Americans
- with large appreciation on their Canadian home
- with a minimal amount of investment income (earned outside of a registered account) expected in the year of sale
- in a high tax bracket.
Remove the sale of home from the U.S. tax net
If a U.S. citizen is looking to buy a home in Canada, it would be prudent to structure the purchase such that title is in the name of a non-U.S. citizen spouse. This would ensure the PRE remains intact on the Canadian side and any sale of the home is not reportable by the U.S. spouse on the U.S. side.
If a U.S. citizen already owns a home in Canada and expects U.S. tax liability on a future sale, the home can be gifted to a non-U.S. citizen spouse. However, annual spousal gifts in excess of USD $185,000 will reduce the U.S. estate tax exemption available. This is a non-issue if the U.S. spouse expects to pass away with a net worth less than the general estate tax exemption (USD $13.61 million as of 2024 but set to decrease to USD $7 million in 2026). For high-net-worth individuals, an interest in the home of up to USD $185,000 can be gifted to the non-U.S. spouse each year until ownership is fully transferred without tapping into the U.S. estate tax exemption.
GG Observations
It is crucial for U.S. citizens to consider the U.S. tax implications of selling a principal residence even before making a purchase. If one already owns a home, it may be worthwhile to take action to remove the asset from the U.S. tax net. GG has cross-border tax experts that can determine the U.S. tax exposure on the sale of a home and help put in place all available mitigation measures.
