How will departure tax impact me?
Question from a Client:
I currently live in Toronto and received a job offer in Houston, Texas. My wife and I are looking to relocate in the next 3-4 months. I’m worried about how much tax I’ll have to pay when I move. I asked my existing financial advisor, and they mentioned it is called departure tax, but they weren’t sure how it would apply to me. The articles I’m reading online are conflicting, saying I’ll have to pay tax on my real estate and investments, but others saying I won’t have any tax? I’m so confused, could you please explain how this departure tax will impact me?
Robert in Toronto
First off, congratulations on the job offer and the exciting cross-border move! You should be focused on this big life change and getting settled in Texas, and not about the intricacies of the Canadian and US income tax systems. I hope my explanation can help provide you with some certainty and important considerations.
Robert, Canadian residents like you and your wife who are exiting Canada for tax purposes face a final Canadian tax bill: the departure tax. This is not an additional tax; rather, it is a final settling of your accounts with CRA in the form of a ‘deemed disposition’ of some of your capital assets which will result in a capital gains tax. This capital gains tax would have occurred eventually upon sale of the assets or upon death; your departure simply accelerates the tax event.
The capital gains inclusion rate in Canada is currently 50%. This means that 50% of your gross unrealized capital gain on some of your capital assets (listed below) on the date of your exit from Canada is added to your annual income for the year of your exit and gets taxed at your highest marginal tax rate (currently as high as 53.53% for Ontario residents with annual income in excess of $235,675 CAD, which results in the highest potential capital gains tax rate at exit of 26.77%).
I mentioned that this deemed disposition only applies to some of your capital assets – but not all. Robert, fortunately there are several assets that are exempt from departure tax, which include:
- Registered accounts (RRSPs, RRIFs, LIRAs, RESPs, TFSAs, RDSPs, etc.)
- Cash and bank accounts
- Canadian real estate (this includes both your primary residence as well as any secondary or rental properties)
- Personal use property valued at less than $10,000 CAD
- Personally owned life insurance
So, with all these generous exemptions, what assets are subject to departure tax? The non-exhaustive list includes:
- Non-registered investment accounts (i.e. taxable brokerage accounts)
- Non-Canadian real estate
- Shares of a business (personally owned shares, e.g. shares of your holding company or of an active business)
- Corporately owned life insurance
Robert, now that we’ve established which assets are subject to departure tax, you can estimate what your tax liability upon your exit from Canada might be. Any unrealized capital gains on your assets subject to departure tax will be deemed to have been disposed for their fair market value on the date you exit Canada for tax purposes. 50% of this gain will then be added to your income for the year and taxed at your highest marginal tax rate.
Robert, because we file taxes individually in Canada, both your and your wife’s income from January 1st up until the date you exit Canada will determine what tax rate your departure tax is subject to. There are obviously multiple variables, and more information is needed to provide an accurate estimate of your departure tax liability; however, it is helpful to know how these assets are taxed.
Finally, a few examples of the important considerations and planning opportunities with respect to departure tax can include (there are many others in addition to the examples below):
- Any unrealized capital losses carried forward from previous years can be used to offset departure tax
- Departure tax owing can be deferred until the death of the second spouse by pledging certain types of security with CRA in a process known as collateral negotiation
- If you have control over the timing of your move, exiting earlier in the year may result in a lower departure tax due to less other income pushing up your capital gains tax rate
- Making a pre-exit RRSP contribution can reduce your taxable income in the year of exit which may subsequently decrease your departure tax owing
- Although non-Canadian real estate is subject to departure tax, if the real estate in question qualifies as your principal residence, you may be able to leverage the principal residence exemption to shelter any tax that would otherwise be owing (property does not need to be located in Canada to qualify for this exemption
Robert, I hope this helps explain how departure tax will apply to you when you exit Canada and provides you with an idea of some of the pre-exit planning opportunities for you and your wife to consider.
In my experience, departure tax varies widely from client to client depending on their situation, incomes, assets, etc. At MCA Cross Border Advisors, we frequently perform this type of analysis for our clients and are well-versed in implementing strategies to reduce or eliminate departure tax with proper analysis and planning, as well as the process of collateral negotiations with CRA.
Wishing you a smooth and successful cross-border journey!
MCA Cross Border Advisors, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. The content of this presentation is for information purposes only and should not be construed as investment or financial advice. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.