If you are a Canadian non-resident, and you sell rental property located in Canada, there is an demanding set of rules you must follow to meet your tax obligations to Canada.
You will be required to pay Canada Revenue Agency (CRA) 25% of the net capital gain on the property up front. When you calculate the net gain, you are not permitted to reduce it by any outlays or expenses related to the sale of the property, such as real estate commissions or legal fees. Rather, you must file a Canadian income tax return at the end of the year and claim your outlays on the return. In practice, this means that you may have to “lend” CRA tens of thousands of dollars for a period of several months, until you can file your return the following year.
The process of reporting the sale of your property can be broken into three steps.
Step 1 requires the filing of an application for a (T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property) within 10 days of the sale closing. In practice, the T2062 can be filed prior to the closing date once a signed agreement is in place. The clearance certificate confirms to the parties involved in the sale that sufficient withholding taxes have been remitted to the Canada Revenue Agency (CRA) and any remaining sale proceeds are eligible to be transferred out of the country. Under Canadian tax legislation, until a clearance certificate is received the purchaser can be liable for Canadian taxes equal to 25 per cent of the purchase price. In order to cover this potential liability, the lawyers in the transaction often hold in trust 25 per cent of the sale proceeds until the clearance certificate is issued. Proceeds in excess of the 25 per cent for withholding taxes, closing costs (e.g. realtor commissions, professional fees, sale price adjustments), and mortgage repayment, if any, are released upon closing.
Step 2 of the process involves the payment of the tax liability as estimated on the clearance certificate. The tax liability will equal 25 per cent of the estimated gain on the property sale as reported to the CRA on the clearance certificate. If the property has been rented and a capital cost allowance deduction has been claimed on the building, the CRA will assess an additional tax liability of 50 per cent on this portion of the gain. The estimated tax liability is then paid to the CRA from the sale proceeds held in trust by the purchaser’s lawyer. At this point, any balance remaining in the lawyer’s trust account is then released upon receipt of the clearance certificate. In the event that rental income has been earned from the property and has not been reported annually to the CRA under Section 216 of the Canadian Income Tax Act (ITA), the clearance certificate will be withheld until all Section 216 returns have been assessed and filed. This can delay the entire process for over a year in some circumstances.
Step 3 involves filing a Canadian tax return under Section 116 of the ITA to recover a portion of the tax liability remitted to the CRA in Step 2. As the effective Canadian tax rate on capital gains will rarely exceed 25 per cent, the withholding taxes remitted in Step 2 often qualify for a partial refund. This tax return is due April 30 of the year following the year in which the sale occurred.
Depending on the time taken to process the application, receipt of the clearance certificate, and, therefore, a substantial portion of sale proceeds, can take as long as four to six months. Processing the final Section 116 tax return can also take as long as six months. It is important to be aware of these timelines in contemplating subsequent investment of sale proceeds.
GST and HST might also apply to non-resident property sales, particularly where commercial or short-term residential rental income was earned from the property.