A number of readers have asked about the relationship between US income taxes and Canadian income taxes, and specifically how to address US rental income on a Canadian tax form. Again, we are not tax professionals and you should seek your own professional advice, but here is what we have done and understand.
First, premises to keep in mind (see previous posts): we hold the properties in US LLPs (one property to an LLP); in the US LLPs file a 1065 return (with attachments) and generate a K1 form showing allocation of profit to each partner, and each partner files a 1040NR reporting the allocated profit as income. While the LLPs introduce an administrative difference (to not using LLPs), the net effect is that rental income ends up being reported and tax paid on individuals' 1040NRs...so from a US taxation result perspective, rental income is personal income and the LLPs are "transparent". I am sure the details can be debated, but that's the net of it.
OK, so what about Canadian Taxes? Well, the general idea is that US personal income is reported to both the US and Canadian Governments independently, and tax paid independently. To avoid double taxation, there is a tax treaty between the two countries that allows tax paid to the foreign (US in this case) government to be recovered on the individual's home (Canada in this case) tax form. The mechanism is a "Foreign Tax Credit". Of course, the "general idea" doesn't always work perfectly, and there are cases where you don't actually get the money back through the FTC. But let's assume the general case when the FTC works.
The rental income must be reported on the individual's Canadian personal tax form, and there seems to be a few ways that it can be done. I haven't been able to get anyone to say "This is the correct way to report it...". I have heard "Yes, none of the ways you suggest would be INcorrect." Great.
For the first few years, what we did was report the income from the 3 properties exactly if they were 3 Canadian properties. So, we converted the income and expenses to Canadian dollars, and reported them on T776 forms...Statement of Real Estate Rentals. There were a couple of challenges with this: 1) There is a minor difference between the expense categories recognized by the IRS (US) and the CRA (Canada), so we had to make sure our accounting spreadsheet accommodated both. If I recall correctly the difference was in the breakdown of Maintenance and Repairs: separate on one and combined on the other. 2) There is a different calculation for depreciation. And 3) the Canadian tax software didn't like a US address...so we had to fudge that.
I have been conversing with a few readers who also have looked into this, and a couple of other alternatives came up. (A) Report the income as "Income from a Foreign Partnership"; or (B) just report the income as foreign income.
(A) Reporting the income as "Income from a Foreign Partnership seems to drive the need to issue a T5013 Foreign Partnership Information Return...which otherwise didn't seem be be required. Ugh.
On the other hand, (B) reporting the income simply as foreign income seems quite straight forward. For the latter, it appears we can simply record the income and foreign tax paid on a "Foreign Slip" in TurboTax. TurboTax would then transfer those totals to the line titled "Other income from foreign slips" on the "Other Income, Deductions and Credits" schedule, and then cascade it to Line 130 "Other Income Specify (See attached schedule)" on the T1 General. Very simple, and provides the input to the Foreign Tax Credit at the same time. I like it.
We haven't yet filed our Canadian Taxes this year, but I will try the "foreign income" route to see how it works in practice. This will imply that we are not doing a separate depreciation calculation in Canada because we are just reporting the net income as calculated by the LLPs, but the difference is minor and I believe the Canadian calculation is a bit more aggressive, so I don't expect anyone to be concerned.
A tax professional that I talked to opined that "none of the above is incorrect", but he did caution that changing methods like I am contemplating may throw up a red flag and may cause questions or even an audit. That is certainly possible, but I think we have been as diligent, conservative, and above board as possible so that does not cause me concern.
Again, we are not tax professionals. Just sharing opinions. Your mileage may vary.
Oh yes...I mentioned above that the FTC doesn't always work. In past posts I have hypothesized that one such case is if you hold the LLPs in a Canadian Corporation...so you are paying personal tax in the US and Corporate tax in Canada. As far as I know personal US tax can't be recovered through a FTC against Corporate Canadian Tax. But another "gotcha" that I have heard is that if one of the partners in Canada doesn't have enough income to require tax to be paid, then the FTC doesn't return tax paid in the US...because the FTC is a credit against tax "to be paid" in Canada, and applying the FTC cannot generate a refund. Grrr.
