Should you stay or should you go now?

There are few greater rewards of hard work and smart wealth management than buying and owning a vacation home. I’ve had more than my share of clients who—when the temperatures dip and the days get shorter—start counting down the days to when they can sink their toes in the sand or get on the golf greens down south. But before they pack up to escape the Canadian winter, I caution there’s something else they should be counting: the number of days they’re in the United States. That tally may cost you.

If you are a Canadian resident who spends several months in the U.S. every year or are in the process of property hunting, it’s important to understand cross-border tax rules. Depending on the length of your stay, the Internal Revenue Service (IRS) may consider you a U.S. resident for income tax purposes. That means, in addition to your Canadian tax obligations, you’ll also be required to file U.S. tax returns and other information-reporting forms. This can get complicated and costly, depending on your financial accounts and holdings. If you don’t comply, you can face significant penalties.

To help you navigate this not-so-sunny side of your dream property, here are some key steps and considerations.

Do the math
Again, whether a Canadian resident has U.S. tax obligations depends on the number of days spent in the U.S. However, the formula for determining this is often more complicated than people realize.

Here is a summary: If you’re not a U.S. citizen or green-card holder, you’re deemed a U.S. resident for tax purposes if you spend 183 days or more in the U.S. in a calendar year. If you were present for more than 30 days but less than 183 days, you will have to tally your days using the “substantial presence test” formula. This includes the time you spent in the U.S. in the current year plus one-third of the number of days spent in the U.S. in the prior year, and one-sixth of the number of days spent in the U.S. the year before that. If that number meets or exceeds 183 days, you are considered a U.S. resident (for tax purposes) in the current year.

As an example, let’s take a client I’ll call Robert, who spent from mid-November to late March 2023, at his vacation home in Florida. At 140 days total, Robert thought he was well below the six months (183 days) he could stay in the U.S. without worrying about taxes. However, Robert spent 90 days in the U.S. in 2022 and 150 days in 2021. The substantial presence test formula would calculate for him as follows:

2023: 140 days + 2022: 30 days (1/3 × 90 = 30) + 2021: 25 days (1/6 × 150 = 25) = 195 days

Since this number (195 days) exceeds 183, Robert is considered a resident in the U.S. for 2023. If the total over the three-year period had been 182 days or less, Robert would not have been considered a U.S. resident for tax purposes. However, this doesn’t necessarily mean Robert will be subject to U.S. taxes, as Canadians may be able to claim an exception.  

True North strong (and extra-tax-free?)
If you (like Robert) weren’t in the U.S. for at least 183 days in the current year, but still meet the test’s threshold, you may qualify for the “closer connection exception.” In this case, you may not be considered a U.S. resident for tax purposes if you have a closer connection to Canada than to the U.S.

How is that determined? In addition to having a permanent home in Canada, the IRS looks at factors such as the location of your family (spouse and children); the location of your car and personal belongings such as furniture, clothing and jewellery; the location of the social, religious, cultural and political organizations you belong to; where your driver’s licence was issued; where you’re registered to vote; where you derive the majority of your income for the year; and whether you’re covered by provincial health insurance in Canada. To obtain the closer connection exception for a particular year, you must file Form 8840 by June 15 of the following year.

Tie breaker
What happens if you cross the 183-day threshold in the calendar year? You can still seek an exception, although the process is more rigorous than the closer connection exception. It’s called the “tie-breaker” rule under the Canada-U.S. Tax Convention (Treaty).

Like the closer connection exception, you can be considered a non-resident of the U.S. if you can establish that you have stronger ties in Canada than the United States. This determination depends on factors such as the location of your primary residence and centre of vital interests, meaning your personal and economic ties.

To claim this treaty exception, you must file a U.S. non-resident tax return. You won’t be subject to U.S. tax on your worldwide income, but you will be required to report the following to the IRS: your non-U.S. bank and financial accounts (FinCEN Form 114); transfers to and distributions from non-U.S. trusts, including certain TFSAs and certain RESPs (Forms 3520 and 3520-A); receipts for certain foreign (non-U.S.) gifts and bequests (Form 3520); and certain non-U.S. corporate and partnership holdings (Forms 5471 and 8865). Failure to file these forms on time can result in significant penalties, ranging from US$10,000 per form to US$100,000 or 50 per cent of certain account balances for willful non-compliance.

Home is where the bar chart says it is
When it comes to tallying your days down south, my advice is to make it your fundamental objective to avoid becoming a U.S. resident. If you spend 182 days or fewer in the U.S. each year, you can minimize your U.S. filing obligations. And if you can avoid spending more than 121 days there in any given year, you won’t be subject to the substantial presence test—and can therefore ensure, wherever you’re hanging your hat, it’s sunny days ahead.