Introduction
On June 25, 2020, the Canada Revenue Agency (CRA) announced plans to review six years of U.S. real estate transactions to identify potential tax non-compliance among Canadian taxpayers. The CRA intends to examine “real estate and property data in bulk form, including municipal addresses, names of owners, square footage, sales histories, and property tax assessments.” This audit will focus on undeclared real estate property or unreported transactions involving U.S. properties owned by Canadian taxpayers.
Canadian taxpayers subject to reassessment in this tax audit may face significant financial repercussions, including penalties, interest, and additional professional fees to respond to the audit. This article outlines the key issues the CRA is likely to target and provides practical advice to address these concerns.
Key Areas of CRA’s Audit Focus
1. Unreported Foreign Property
Canadian taxpayers holding foreign properties valued over $100,000 CAD must comply with the T1135 reporting requirement, regardless of whether the property generates income. Failure to file this form can result in penalties:
- Penalty for Late Filing: $25 per day (up to a maximum of $2,500) for filings overdue by 24 months or less.
- Penalty for Prolonged Non-Compliance: 5% of the property’s cost if the failure exceeds 24 months. The calculation may vary if the property is held in a trust or consists of shares or bonds.
Exemption: Personal-use foreign properties not generating income are exempt from T1135 reporting. However, owners must maintain sufficient documentation to support this classification.
2. Unreported Rental Income
Canadian tax residents are required to report worldwide income, including rental income from U.S. properties. While the Foreign Tax Credit prevents double taxation, unreported U.S. rental income can trigger reassessment by the CRA.
- Potential CRA Findings:
- Failure to Report Income: Entire rental revenue not disclosed.
- Inaccurate Revenue or Expense Claims: CRA may challenge reported rental income or expenses deducted.
Documentation is critical in substantiating both income and deductible expenses. Failure to provide adequate records may result in reassessments and penalties.
3. Unreported Real Estate Sales
The CRA is likely to scrutinize the sale of U.S. properties owned by Canadian taxpayers, particularly non-principal residences. Taxable sales proceeds will be assessed as either income or capital gains, subject to provisions under the Canada-U.S. Tax Treaty.
- Principal Residence Exemption Reporting:
- Properties sold after October 3, 2016, must be reported to the CRA, even if the property qualifies for the principal residence exemption.
- Failure to Report: May incur a penalty of up to $8,000 and require taxpayers to prove the property qualifies as a principal residence.
Important Consideration: Canadian tax residents may claim the principal residence exemption on U.S. properties if they meet CRA’s criteria. However, defending such claims during an audit can be costly and time-consuming.
CRA’s Audit Process
The CRA’s announced review will rely on bulk data, including property transaction records and tax information from U.S. entities. This initiative stems from a tender notice titled "Bulk United States (U.S.) Real Property Data (re Canadian residents)," signaling CRA’s intent to collaborate with U.S. vendors for detailed property data.
How to Prepare: Proactive Steps for Compliance
- Evaluate T1135 Compliance:
- Ensure all eligible foreign properties are reported as required.
- Gather supporting documents, including purchase agreements, bank statements, and property assessments.
- Review Rental Income Reporting:
- Verify that all rental income and deductions are accurately reported.
- Maintain detailed records, including receipts for expenses and income statements.
- Report Real Estate Sales:
- File principal residence sales post-2016 with the CRA.
- Seek professional guidance to address potential classification disputes.
Voluntary Disclosure Program: An Option for Non-Compliant Taxpayers
Taxpayers who discover past non-compliance with U.S. real estate transactions may consider the CRA’s Voluntary Disclosure Program (VDP). This program allows taxpayers to correct errors or omissions proactively, potentially avoiding penalties and prosecution.
Key Conditions for VDP Eligibility:
- Voluntary disclosure must be initiated before the CRA contacts the taxpayer regarding the issue.
- Full disclosure of previously unreported income or properties is required.
Conclusion
The CRA’s focus on U.S. real estate transactions underscores the importance of compliance with reporting and tax obligations. Taxpayers holding U.S. properties or engaging in transactions should review their tax filings to ensure compliance and mitigate potential audit risks.
If you have concerns about CRA’s audit or require assistance with unreported U.S. real estate transactions, our experienced accountants can guide you through the process. Proactively addressing compliance issues can help minimize penalties and prevent further complications.
This article is written for educational purposes.
Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.
Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.
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