People who retire to the Sunbelt face what amounts to a “departure tax”. But changes to the Canada-U.S. Tax Treaty will take some of the sting out of it.
The story didn’t receive a lot of attention in the media but one of the changes to the Canada-U.S. Tax Treaty announced in September has important implications for snowbirds.
Officially known as the Fifth Protocol to the Canada-United States Income Tax Convention, the deal, which was 10 years in the making, was signed on Sept. 21 by Finance Minister Jim Flaherty and U.S. Secretary of the Treasury Henry M. Paulson, Jr. It must be ratified by Parliament and the U.S. Senate before it becomes law. Mr. Flaherty said enabling legislation would be introduced into the House of Commons this fall and urged all parties to support it.
One of its provisions is of special interest to Canadians who decide to emigrate to the U.S. Many of these people are snowbirds who want to spend their retirement years in the Sunbelt. Right now, this can be a very expensive proposition from a tax perspective.
Most people don’t realize it until they begin to plan for a cross-border move but this country effectively imposes a departure tax on emigrants. Of course, we don’t call it that, but it amounts to the same thing. When you leave, the Canada Revenue Agency (CRA) treats your assets as though you had died, taking the position virtually all the property was disposed of at fair market value. Any capital gains are taxed accordingly. However, there is no offsetting provision on the U.S. side to recognize this “departure tax”, so you could be taxed there again on the same profit.
As a result, it currently makes more sense to sell the asset and repurchase it after moving to avoid this. The Fifth Protocol will change the situation by allowing an emigrant to begin with a fresh slate for capital gains purposes when he/she takes up residence in the other country – in this case, the U.S.
For example, suppose you decide to retire to the States and you own shares with a market value of $10,000 for which you paid only $4,000. When you leave Canada, the CRA will collect tax on $6,000 worth of capital gains. Under the old rules, if you didn’t actually sell the shares, the U.S. Internal Revenue Service still required you to show them at the original $4,000 book value for purposes of calculating U.S. capital gains tax when you sell.
When the Fifth Protocol takes effect, you will get credit for the taxes paid in Canada and be able to show a book value of $10,000 for your shares for U.S. tax purposes, even if they were never actually sold. Any future capital gains tax liability will be based on that amount.
Adapted from an article that originally appeared in The Income Investor, a twice-monthly newsletter that focuses on income-generating securities, including bonds, preferred shares, mutual funds, income trusts, and REITs. For details on how to subscribe to The Income Investor go to http://www.buildingwealth.ca/promotion/50plusproducts.htm