A Canadian corporation's US rental: filings and sale tax

What does a Canadian corporation with a US rental file each year?

A Canadian corporation files Form 1120-F when its US rent is effectively connected income: income taxed as part of a US business, including rent brought into that treatment by election. The filing requirement can apply even when the rental produces a loss. The corporation also reports the rental on its Canadian T2. IRS filing responsibilities.

Three taxes can stack on the same rent: US tax on net rent (or on gross rent without the election), branch profits tax, and Canadian tax on the T2 with a credit for US tax paid. This page assumes the corporation owns the property directly; to compare ownership choices, see how a Canadian should own US property.

For a directly owned rental, the US filing work usually includes:

Form 7004 extends the time to file, not the time to pay. Regular corporate tax on effectively connected taxable income is 21%; estimated payments may also be required. Form 1120-F instructions.

State rules are separate. For example, a corporation doing business, earning income or existing in Florida generally must file Florida Form F-1120 each year, even if no Florida tax is due. Florida corporate income tax, Florida Statutes section 220.22.

What happens if tenants pay the gross rent and the corporation does nothing?

US rent that is not effectively connected income generally faces tax at 30% of gross rent, without deductions for mortgage interest, repairs or other expenses. Receiving the full rent in the corporation's bank account does not remove that tax. IRS gross-income rules.

Withholding is how the US collects that tax, not what makes it due. The payer generally must withhold and report it and is itself liable for tax it should have withheld, but tenants or managers may pay the full rent and withhold nothing. A foreign corporation with US-source income must file Form 1120-F if withholding did not fully satisfy its tax, and penalties may apply for filing late or not at all. A corporation with no US trade or business whose rent was correctly withheld in full may be exempt from filing. IRS filing responsibilities, Form 1120-F instructions, payer liability.

Whether the rental already makes the rent effectively connected depends on the facts, before any choice of filing basis.

What is the net-income election, and how does the corporation make it?

A foreign corporation can elect under section 882(d) to treat qualifying US real-property income as effectively connected income. That allows connected expenses to enter the net-income calculation, subject to the deduction and filing rules. Real-property election regulation.

1. Get a US employer identification number (EIN) with Form SS-4 if the corporation has none. Without a US legal residence, principal place of business or office, it cannot apply online. Instructions for Form SS-4.
2. Attach an election statement to Form 1120-F for the first applicable tax year, listing every US property, the corporation's ownership interest, substantial improvements and any earlier election or revocation history.
3. Report the elected income in Section II of Form 1120-F.
4. Give the rent payer a completed Form W-8ECI, with the corporation's EIN, before rent is paid. It documents the income's status; it does not replace the election. W-8ECI instructions.

The election covers all qualifying US real-property income, not just the property with the largest expenses. It continues into later years. Revoking it after the initial election period needs IRS consent, requested in writing within 75 days after the close of the first year the change should apply, so it is a multi-year decision. Election requirements.

Mortgage interest is not simply deducted as paid. A regulation formula allocates interest to rent treated as effectively connected, reported on Schedule I, so it can differ from the loan statement, and a related excess-interest tax may apply. Interest allocation regulation, Form 1120-F instructions.

What is branch profits tax, and does the treaty reduce it?

Branch profits tax is a separate US tax on a foreign corporation's dividend equivalent amount: broadly, after-tax US earnings that are not kept invested in US assets. The domestic rate is 30%. For a Canadian corporation that qualifies for treaty benefits, Article X(5) and (6) let the US impose it only on earnings attributable to a permanent establishment, at no more than 5%. Form 1120-F, Section III, treaty Article X.

The amount depends on changes in US net equity: qualifying US assets less allocated liabilities. Reinvestment can reduce it, a later reduction can expose accumulated earnings, and cash left in a US account does not by itself establish reinvestment. Branch profits regulation.

The treaty allowance is C$500,000, or its US-currency equivalent, reduced by prior use by the corporation or associated corporations for the same or a similar business; all US real property interests count as one such business. It is not a fresh annual allowance. Article X(6)(d), real-property business rule.

Two points decide how the treaty applies. First, Canadian incorporation alone does not establish eligibility: the corporation must satisfy Article XXIX A, the limitation-on-benefits rules. For a closely held company, the usual tests look at who owns the shares and how much deductible expense it pays to others. The active-business test excludes making or managing investments, and a corporation that fails can ask the US competent authority for relief.

Second, whether the earnings are attributable to a permanent establishment, generally a fixed place of business in the US through which the corporation carries on business, is a question of facts for each rental. The rental election alone does not establish that the corporation carries on a US trade or business. Gain on a sale follows separate rules, covered below. Treaty Articles V and XXIX A, branch-tax treaty rules, effect of the rental election.

A corporation that claims the treaty exempts it from, or reduces, branch profits tax generally must disclose that position on Form 8833; the penalty for not disclosing is US$10,000 per failure for a C corporation. Form 1120-F instructions, item W(1), disclosure rule.

What does the corporation file in Canada for the US rental?

A Canadian-resident corporation includes US rental income in its Canadian income calculation and files a T2 annually, even if the rent stays in the US. Worldwide-income rule, resident corporation filing rule.

Use Canadian tax rules rather than copying the net income from Form 1120-F. Canadian currency is generally required unless a valid functional-currency election applies. T2 income and depreciation schedules, currency rule.

A US rental generally requires T1135 reporting if the total cost of all specified foreign property exceeds C$100,000 at any time during the year; property held exclusively for an active business is excluded, so classify the rental first. T1135 is due with the T2, generally six months after year-end. CRA foreign-property rules, T2 deadline.

How does the corporation claim US tax on its T2?

The corporation calculates eligible foreign tax credits on Schedule 21. A credit reduces Canadian tax within the applicable limits; it does not guarantee that every US payment comes back. Schedule 21.

Rental property income generally uses the foreign non-business income tax credit (T2 line 632); a rental that is a business carried on outside Canada may use the business credit (line 636). The US net-income election does not decide that classification. CRA foreign tax credit guidance, Income Tax Act, section 126.

FIRPTA withholding is reconciled with the final US liability, not treated automatically as final foreign tax. FIRPTA credit procedure. For limited credits, excess tax and timing differences, see claiming US tax on a corporate return.

How is rent taxed on the T2, and when can some tax come back?

On the T2, rent from a US property is generally investment income: the corporation pays tax on it in the year, and part is refundable later when it pays taxable dividends. For a Canadian-controlled private corporation or a substantive CCPC (broadly, a private corporation controlled by Canadian residents), that includes additional refundable tax of 10 2/3%, which is not the combined tax rate. CRA investment-income tax, Income Tax Act, section 123.3.

The refundable portion sits in the non-eligible refundable dividend tax on hand account, or NERDTOH. Paying taxable dividends can release a refund, within the account and dividend limits, if the corporation files the relevant return within 3 years after the end of the year it paid them. CRA refundable-tax and dividend rules.

The small business deduction is for active business carried on in Canada, so US rent generally does not qualify for it; for a corporation that also runs an active business, rental income can reduce the deduction. CRA small business deduction, Income Tax Act, section 125. For rates, provincial differences, that reduction and dividend calculations, see holding and investment corporations.

What is withheld when the corporation sells, and what does it file?

The buyer generally withholds 15% of the foreign corporation's amount realized under FIRPTA: cash, other property received and relevant liabilities assumed or attached to the property, not the gain or the cash left after the mortgage. Exceptions or an IRS withholding certificate can change the withholding, but only on their own conditions. A buyer that fails to withhold may be held liable for the tax. IRS FIRPTA rules.

The US treats the property-sale gain or loss as effectively connected even without a rental election or an actual US business, so the net gain is taxed at the regular 21% corporate rate and the withholding is credited against that tax. Give the buyer the corporation's EIN: without it on Form 8288-A the IRS sends no stamped copy, and the corporation must attach closing documents and a withholding statement to claim the credit. The final return shows whether more tax or a refund results. Sale reporting on Form 1120-F, FIRPTA reporting.

If Form 8288-B was filed on or before closing and is still pending, the buyer still withholds; remittance waits until 20 days after the IRS mails its decision, and the seller does not get the funds. The corporation must tell the buyer in writing, on the closing day or the day before, that it applied. Certificate rules, pending-application procedure.

Canada calculates the sale separately, using Canadian tax costs and depreciation history. For capital property, generally 50% of a capital gain is taxable, and capital cost allowance recaptured on the sale is fully included in income. Reporting the closing cash alone misses both. Canadian disposition schedules, taxable capital gain, recapture.

Is branch profits tax due on the sale or when proceeds go to Canada?

Neither the sale nor a transfer to Canada decides it alone. The tax turns on the year's after-tax US earnings, which include the sale gain, and on the change in US net equity, as described above. For a corporation entitled to treaty benefits, the regulations impose the tax only on earnings attributable to a permanent establishment or, where the treaty does not prohibit it, gain on a US real property interest. Branch profits rules.

Complete termination of all US business can provide branch-tax relief, but selling the last building does not automatically satisfy it. The conditions include no US assets at year-end and, for three years afterward, no use of the assets or proceeds in a US business by the corporation or a related corporation and no effectively connected income. A waiver, generally Form 8848, must be filed by the return deadline, including extensions. Failing the conditions can restore branch tax with interest and penalties, and distributing or reinvesting the proceeds can change whether they are met. Complete-termination conditions, waiver requirements.

A shareholder who receives the proceeds can become liable, up to the value received, for the corporation's unpaid tax: in the US as a transferee, within one year after the corporation's own assessment period ends, and in Canada under section 160, if not at arm's length and paying less than the property's value, assessable at any time. US transferee rule, Canadian transferee rule.

We never filed Form 1120-F: can we still deduct expenses?

It depends on how late the return is. A Form 1120-F filed within 18 months after its due date generally preserves the corporation's deductions and credits; after that they are generally lost unless the IRS grants a waiver, except the credit for US tax withheld at source, which a late return still claims. Where the preceding year's return was also not filed (and this is not the corporation's first year needing a return), the window ends earlier if the IRS mails a notice that the current-year return is missing. IRS filing instructions, Deduction and waiver regulation.

A waiver requires that the corporation acted reasonably and in good faith in not filing; a corporation that knew it had to file and chose not to does not qualify, and none is granted unless the corporation cooperates in determining its tax. The rental election has its own deadline for its first year: the later of 3 years after filing the return or 2 years after paying the tax. Election timing. For the recovery process, see missed US returns for a Canadian corporation.

What if the shareholder or family stays in the property?

Free or discounted personal use of a corporation's US property can create a Canadian shareholder benefit. Section 15 can also cover benefits conferred on family members who do not deal at arm's length with the shareholder. Shareholder-benefit rule.

A use calendar, rental agreement, proof of rent paid and support for the property's rental value show what happened. Valuation depends on the arrangement; see a home owned by your corporation.

Example

An Ontario holding company directly owns a Florida rental. All numbers are illustrative and in US dollars.

Assume annual gross rent is $40,000 and allowable US deductions are $20,000. If the rent is non-connected and no election applies, gross-basis federal tax at 30% is $12,000. With a valid net-income election and preserved deductions, taxable rent is $20,000; regular federal corporate tax at 21% is $4,200. These figures exclude branch, state and Canadian tax, so the gap is not what the election saves; the election also continues in later years.

Later, assume the corporation sells for $600,000 cash, with no liabilities assumed, no non-cash consideration and no withholding exception. FIRPTA withholding at 15% is $90,000, which does not establish the final tax. If the US gain were $200,000, federal tax at 21% would be $42,000, and the $48,000 difference would be claimed as a refund on Form 1120-F, before state and branch tax. The T2 reports a separately calculated Canadian result.

What should the corporation gather before filing or selling?

Before a sale or when catching up missed years:

• Ownership records, EIN, year-end, deed, closing statement, land/building allocation, improvement invoices, leases, rent ledgers, loan records and expense invoices.
• Prior Forms 1120-F, election statements, W-8ECI forms, T2s and T1135s, with US depreciation and Canadian tax-cost and capital cost allowance schedules.
• Tax payment, refund and withholding records, IRS or CRA notices, US asset and liability balances, prior treaty-allowance use, and any sale agreement or family use calendar.

Different for you?

• The property is inside a US LLC: entity classification changes the filings and credit analysis; see Canadian owner of a US LLC.
• You own the rental personally: use Canadian owners of US rentals and Canadians selling US real estate.
• Past US returns are missing: late filing can cost the US deductions; see missed corporate US returns and bring the filing history and IRS notices to cross-border tax review.
• A shareholder is a US citizen or green card holder: the US may require that shareholder to report the Canadian corporation, for example on Form 5471; see American owners of Canadian corporations. If US citizens or residents, or residents of a third country, own 50% or more of the voting shares by value through the last half of the year, treaty Article X(8) also lets the US apply its accumulated earnings and personal holding company taxes (with exceptions). Treaty Article X(8).
• The corporation has an establishment in Quebec or Alberta: those provinces run their own corporate tax, so a CO-17 or AT1 return is also filed (an Alberta exemption may apply); see which returns your business files. CRA, Revenu Québec, Alberta.
• You plan to reinvest the proceeds in another US property: a like-kind exchange can defer the US gain if the replacement is identified within 45 days and received within 180 days, or by the return due date if earlier; Canada generally does not follow the deferral. See exchanging a US rental and section 1031.
• A sale is pending, or treaty eligibility or branch termination is uncertain: bring the records listed above to cross-border tax review before closing or moving proceeds.