The Canadian income tax system has a sensible rule that treats immigrants into the country “as if” they had sold their non-Canadian assets just prior to becoming a Canadian income tax resident.
- If you owned certain properties, other than taxable Canadian properties, while you were a non-resident of Canada, we consider you to have sold the properties and to have immediately reacquired them at a cost equal to their fair market value on the date you became a resident of Canada. This is called a deemed acquisition.
- Usually, the fair market value is the highest dollar value you can get for your property in a normal business transaction.
- You should keep a record of the fair market value of your properties on the date you arrived in Canada. The fair market value will be your cost when you calculate your gain or loss from selling the property in the future.
The U.S. does not have such a rule generally for immigrants coming to America. Instead, the non-U.S. citizen will typically have their historic tax basis (by applying U.S. tax principles) in the property they own prior to coming to the U.S. For instance, an immigrant from the South American continent who owns real estate in their country of citizenship, may have a large “unrealized gain” in that property for U.S. federal income tax purposes.
This means that if the South American sells the real estate, while being a U.S. income tax resident (after immigrating to the U.S.), the gain in the South American real estate will be subject to taxation in the U.S. This is very different from the sensible Canadian rule, which exempts the appreciation in the property of the immigrant while living outside of the North American continent.
This can be a very bad result for the uninformed immigrant, since the example above can get worse, when the immigrant to the U.S. has received properties in the form of gifts (e.g., from their family members) which could have very low tax bases per U.S. tax law. Assume a gift of South American real estate received by the immigrant prior to moving to the U.S. with a low historic basis of US$500K. Assume further it is sold for US$3.3M while the immigrant is residing in the U.S. If the property was worth US$3.2M when she immigrated to the U.S., only US$100K of appreciation occurred while residing in the U.S. Nevertheless, under U.S. law, the entire US$2.8M gain (US$2.7M of which occurred while living outside the U.S.) will generally be subject to U.S. federal income tax.
This comes as quite a surprise to many.
An immigrant to Canada in the same case, would only have US$100K of taxable gain, with the US$2.7M gain being free from taxation under Canada’s “deemed acquisition” rules.
There is one exception in the U.S. tax law. Unfortunately, it applies to “covered expatriates” who readers of this site understand, that the U.S. tax regimes are typically quite undesirable. They are as follows:
- The “Mark to Market” taxation on unrealized gains of worldwide assets, arising from the renunciation of U.S. citizenship or termination of “long-term residency” status (i.e., the so-called “exit tax”); See, Inflation Adjusted Exclusion Amounts Since Inception of 2008 “Mark to Market” Expatriation Tax Law: Example and
- The tax payable by U.S. beneficiaries whenever they receive so-called “covered gifts” and/or “covered bequests.” See, The “Hidden Tax” of Expatriation – Section 2801 and its “Forever Taint.” (April 2014) and a post from September 2015, Finally – Proposed Regulations for “Covered Gifts” and “Covered Bequests” Issued by Treasury Last Week (Be Careful What You Ask For!).
The statutory provision under IRC Section 877A(h)(2) provides relief from the first tax; for purposes of calculating the “mark to market” tax. It provides in relevant part that the “covered expatriate” –
- . . . shall be treated as having a basis on such date [the date of immigration to the U.S. in the first place] of not less than the fair market value of such property on such date . . .”
Accordingly, the appreciation of the property owned by the immigrant (see, US$2.7M example above – who is in the process of emigrating out of the U.S. -by way of “covered expatriate” status) will generally escape income taxation under IRC Section 877A(h)(2) on the unrealized gain in the property that arises prior to moving to the U.S. in the first place. This limited rule is similar to the sensible Canadian “deemed acquisition” rules.
Unfortunately, there is no such rule as this “deemed acquisition” concept that could reduce the future tax payable by U.S. beneficiaries of “covered gifts” and “covered bequests.”