Podcast Episode 124: “Non-Resident Taxes Part II.”
Like all things tax related, non-resident tax is complicated when it comes to buying and selling real estate in Canada. In February, 2016, I posted a lengthy blog on non-resident tax and how it can affect buyers, sellers, and realtors. Lots of liability and dangerous situations here, folks, so don’t treat non-resident tax lightly. If you have a non-resident tax situation, please read the previous post (link), and then dive into the case study below. This follow-up blog post provides a recent example from Edmonton law firm (RMLO Law LLP), which I’ll use to show some principles that can be applied to non-resident tax issues in general.
What Is Non-Resident Tax and How Does it Apply to the Sale of Property in Canada
In brief, the Canada Revenue Agency (CRA) says a buyer of real estate from a non-resident seller is responsible for the non-resident seller’s tax, if any, that might be due on sale of the property. Why does the CRA takes that position?
The reason is that non-Residents have basically no restrictions on them when they buy non-farmland property in Canada. And, even then, only a few restrictions in a few provinces. So, a non-resident comes to Canada and buys a property, no problem. What happens if that same non-resident pulls up stakes, sells their property, and leaves Canada? If they made some money on the purchase, but didn’t deal with any tax that might be payable, it leaves the CRA chasing a non-resident who has left the country. Not a good situation if you are the CRA.
To get around the problem of having to chase non-residents in foreign jurisdictions, the CRA has placed the liability for the seller’s tax squarely on the shoulders of, guess who, the buyer! Depending on whether the sale is of non-depreciable property or depreciable property, the tax can be 25% or 50% of the gross sale proceeds. Nope, that’s not the equity in the property or any profit the seller might have made, but rather it’s the total sale price. Yikes!
Case Study on Non-Resident Real Estate Tax in Alberta
For example, I acted for a seller in the recent sale of a principal residence, which was a non-depreciable property with a price of $580,000 and a remaining mortgage balance of $475,000. The CRA rule states that 25% of the sale price of $580,000 ($145,000) must be held back by the buyer until the seller produces a Certificate of Compliance from the CRA stating that the seller has paid all applicable tax, if any. My seller believed that he would have no tax to pay, because not only had he suffered a loss on the sale, but he was also selling a principal residence and could take advantage of the principal residence exemption. The buyer said that was all well and good, but they wouldn’t know for sure whether the CRA agreed with the seller until they received CRA’s Certificate of Compliance. Therefore, the fact that the seller is selling his principal residence at a loss does not affect the buyer’s responsibility to withhold 25% of the sale price.
You can see the problem. A sale price of $580,000 with expenses of $475,000 to pay out the seller’s existing mortgage, $24,400 for real estate commission, and $1,500 for the seller’s legal account leaves about $79,000. If the buyer is obligated to hold back $145,000, the seller won’t receive enough sale proceeds to pay off his existing mortgage—let alone his other expenses. And, of course, the buyer wanted a clear title with the old seller’s mortgage paid in full. My seller could not make up the shortfall, because he had no access to extra funds. All his money was tied up in the property.
To add to the problem, the seller cannot apply for the Certificate of Compliance from the CRA until he has an unconditional deal with his buyer. This tax problem was preventing the deal from becoming unconditional.
The CRA takes variable amounts of time to process Certificate of Compliance applications. But a pretty good guess is a minimum of three months in a relatively simple situation to get a favourable answer in the form of the Certificate of Compliance.
Sample Solution for Dealing with Non-Resident Tax Problems in Canadian Real Estate Transactions
What to do? The two realtors involved worked hard to find a resolution. Could the completion date the postponed for three months? That would give the seller time to make his Certificate of Compliance application to the CRA. The buyer loved the home, but circumstances wouldn’t allow waiting another three months. Plus, everyone was fixated on the fact that the CRA rule said the buyer should hold back $145,000 and there wasn’t $145,000 to hold back. What if the tax payable was more than $145,000?
The next proposal was that the buyer would rent the property for three months while the seller made his application to the CRA. The buyer would have the right to close sooner or extend the lease depending on the CRA response. Again, the uncertainty of the situation prevented this scenario from becoming the solution to the problem.
In the end I drafted an addendum to the real estate purchase contract. That addendum contained all the facts around the seller’s original purchase price, including substantial upgrades, and comparing it to the sale price, which showed the seller was losing $130,000 on the sale. All paperwork was available for the buyer’s review. The seller confirmed that he had retained chartered accountants to prepare his application for the Certificate of Compliance for this sale of his principal residence. As the seller’s lawyer I agreed to hold the net sale proceeds of about $79,000 in trust until the CRA had responded to the Certificate of Compliance application. Should any tax be payable, I further agreed to use the holdback monies to pay the tax.
This solution worked because the buyer was able to see all the background and all the numbers, providing strong evidence for the seller’s position that there was no tax to pay.
Will this solution work in other similar situations? It depends.
Key Success Factors in Dealing with Non-Resident Tax Problems in Canadian Real Estate
In the case study above, my client’s deal was difficult to close because of the required CRA holdback. The success factors for my resolution of the problem could be applied to many other non-resident tax situations.
- Be aware of the non-resident tax rules,
- Get to work early on the problem,
- Get the seller’s accountants involved,
- Seller must fully disclose all relevant financial information, and
- Hope for a reasonable and/or flexible buyer
Lastly, folks, it goes without saying, but I’m going to say it anyway: tax issues are always complicated, so don’t try to do this on your own. Get advice and get it early from your trusted realtor, accountant, and lawyer.