Managing Capital Gains When Moving to the U.S. With Investment Executive (IE)
Carson Hamill CIM®, CRPC®, FCSI® Associate Portfolio Manager & Assistant Branch Manager had the opportunity to discuss “Managing capital gains when moving to the U.S.” with Investment Executive (IE). CLICK HERE to visit their site or read the article below.
Leaving Canada means planning for departure tax, transfer of non-registered assets
The grass is always greener on the other side — the other side of the border, in this case.
The number of people moving to the U.S. from Canada hit 126,340 in 2022, an increase of nearly 70% from a decade earlier, based on data from the American Community Survey that CBC News compiled last year.
Kim Moody, founder of Moodys Private Client Law LLP in Calgary, can attest to the trend, at least anecdotally. In the past five to seven years, his firm of about 80 professionals has begun working on roughly 600 cases of clients moving to the U.S. That represents billions of dollars leaving the country, Moody said, and compares to about a dozen cases in the first two decades of his 30-year career.
Economic challenges and higher taxes push people to move, he said, referencing measures such as the hike in the top federal tax rate in 2016 and the 2018 tax changes affecting small businesses.
Last year the federal budget proposed raising the capital gains inclusion rate to two-thirds, from half, on gains realized by corporations and trusts and on annual gains above $250,000 for individuals. The changes were supposed to be effective June 24, 2024, but in January, Finance deferred them to 2026. Those proposed changes expedited the move stateside for clients who were already considering it, said Carson Hamill, an associate portfolio manager with Snowbirds Wealth Management, Raymond James Ltd., in Coquitlam, B.C. While the capital gains changes drove some clients to move, “motivation was already there because of the higher tax rates across the board in Canada versus the U.S.,” said Matt Altro, president and CEO of MCA Cross Border Advisors Inc. in Montreal.
“We need better tax and economic policy so that, ultimately, it doesn’t become that tipping point to encourage Canadians to leave,” Moody said. As things stand, he summed up the client sentiment: “For the betterment of my family [and] my life, and if I can get better tax results, then I’m out of here.”
Getting out of Canada means paying departure tax, or capital gains on certain assets deemed disposed at fair market value on exit date. These include investments in non-registered accounts, private corporation shares and real estate outside Canada. Exemptions to departure tax include Canadian real estate, property used in a business in Canada, investments in registered plans, employee benefit or pension plans, employee stock options and personally owned life insurance.
“It’s about understanding the capital gain … planning for it, reducing it and potentially deferring it,” Altro said. Clients who already sold assets to avoid the proposed increase to the capital gains inclusion rate have fewer gains in departure, he added.
Hamill said some clients triggered gains last year before June 25 to avoid the proposed increase to the capital gains inclusion rate. For example, some young professionals were concentrated in tech stocks such as Google and Meta, and “we had to manage the [tax] risk,” Hamill said.
If clients plan to exit within the next couple of years and have significant accrued gains, it may make sense to “chip away and trigger some gains this year, for each spouse potentially,” Altro said, to leverage the 50% capital gains inclusion rate below the proposed $250,000 threshold.
Using the current inclusion rate, 50% of capital gains from deemed dispositions would be added to the client’s income for their last year in Canada and taxed at their highest marginal tax rate. (In Ontario, for example, that rate is 53.53% for income of $253,414 and over, putting the capital gains rate at 26.76%.)
Departure tax can be offset with realized capital losses carried forward from previous years. A client could also potentially offset departure tax by selling an asset with a capital loss that’s exempt from the deemed disposition, such as business property. RRSP contributions and charitable donations, including securities in a non-registered account with accrued gains that are donated in kind, would also help reduce tax liability.
Departure tax can be deferred until the earlier of when the assets are sold, upon re-establishing Canadian tax residency, or until death, if an election is filed on the exit tax return and adequate security, such as a letter of credit or lien on assets, is provided to the CRA. Individuals may also be able to elect to unwind departure tax if they subsequently move back to Canada.
Pre-move planning with non-registered accounts
In addition to being subject to the deemed disposition at departure, a non-registered account requires a strategy to be transferred to the U.S.
“From a compliance perspective, advisors can’t manage [a non-registered account] in Canada once [clients] have a U.S. address and [are] U.S. residents,” Altro said. Also, clients need to show their ties are shifting to the U.S. “to ensure that Canada doesn’t continue to consider [them] a resident.” Consolidating Canadian banking accounts, for example, helps demonstrate that shift.
Further, the U.S. considers Canadian mutual funds and ETFs as passive foreign investment companies (PFICs), which require annual filing of Form 8621 and can be subject to high tax when sold. As such, clients need a “PFIC cleanse” before they move, Altro said.
A client who’s held a mutual fund for a long time can have significant capital gains, so liquidating all at once wouldn’t be ideal. Ahead of a move, “if you can strategically offset [the gain] over years, it’s beneficial,” Hamill said.
Given the weak loonie and unfavourable foreign exchange rate, the client could sell the investment funds and then buy Canadian stocks and bonds, Hamill said. He added that an investment firm registered on both sides of the border can move non-registered accounts to the U.S. in kind.
When realizing gains on assets deemed disposed at departure, “what’s super important is that you don’t end up getting double tax,” Altro said. “The solution is to file a treaty-based election on your first U.S. tax return to step up your [cost] basis for U.S. purposes.”
However, if the client is moving to one of the 13 states that doesn’t align with the Canada-U.S. tax treaty, such as California, the election doesn’t solve for state tax, Altro said. In such cases, the client’s cost basis won’t be stepped up for state tax purposes.
Keeping a home in Canada
If a client wants to keep the residential property they own in Canada, they can potentially do so by leveraging the tax treaty and tiebreaker system, which applies when a person qualifies as a resident of both Canada and the U.S. For example, if the client has a home available in each country, the tiebreaker for tax residency is personal and economic ties, as opposed to a home.
Under the treaty, the residence’s cost basis is automatically stepped up at departure, and the principal residence exemption can be used to cover the gain for the period the home was the client’s principal residence. The home is then exposed to capital gains tax only on new growth post-exit, Altro said.
“Make sure that both people [in a couple] own the property,” Altro said. That way, on gains above the proposed $250,000 threshold, “you can double up on the 50% inclusion rate in future years when you actually dispose of the property.” If the proposed capital gains tax changes don’t pass, this would still be advantageous if one spouse has a lower income.
Tax implications of registered accounts
Clients don’t have to close registered accounts but should consider the associated tax implications.
A lump-sum RRSP withdrawal is subject to a Canadian non-resident withholding tax of 25%. However, periodic payments from a RRIF can qualify for withholding tax of 15% under the Canada-U.S. tax treaty. (Certain criteria must be met.)
On a $2-million RRSP, the U.S. resident saves $780,000, Altro said. “Canada is so much nicer to non-residents than to their own residents when it comes to RRSPs,” he said. “When you take [withdrawals] as a wealthy Canadian, you’re paying almost 54% in most of our provinces.”
Withdrawals are also taxed in the U.S. in the year of withdrawal. To avoid double taxation, federal foreign tax credits can be claimed on U.S. tax returns.
In the 13 states that don’t follow the Canada-U.S. tax treaty, the RRSP acts as a non-registered account, with both the income and growth taxed annually (depending on the particular state’s tax), Hamill said. Before moving to such states, clients could crystallize capital gains on their RRSP investments, he said, then re-buy the investments after the move, resetting the cost basis. Again, the client would file the treaty-based election on their first U.S. tax return.
Keeping a TFSA results in “more cumbersome” filing, Hamill said.
The U.S. may treat the account as a foreign trust. Income earned during the year is taxed in the U.S., and contributions can no longer be made.
Hamill suggested a TFSA be liquidated before moving and proceeds put in a non-registered account. But again, with the exchange rate unfavourable, he suggested keeping the proceeds in Canadian currency until the rate improves.
About Snowbirds Wealth Management
Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focused on the cross-border market. Together with Dean Moro and Carson Hamill, associate portfolio managers with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States. Licensed in both Canada and the US, they provide tailored investment solutions to minimize the tax burden when moving assets across borders.To schedule an introductory call, please click here.
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