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As we all know, tax rules between Canada and the US ca be quite different. Not properly assessing your US investments before moving to Canada can result in often terrible tax inefficiencies.

Outlined below are 5 important investment changes that should be considered before moving to Canada.

Tax free municipal bonds are only tax-free for US purposes

I see lots of muni-bonds in US portfolios for clients that I help with planning before they enter Canada. Often including a mix of muni-bonds in US portfolios can not only help boost portfolio yields but also assist in reduction of taxes. The tax advantages are one of the main selling points of these bonds as the yields themselves as not always more competitive than alternative bonds.

If not sold before entering Canada the interest on these bonds will be fully taxable in Canada, thereby eliminating the tax advantages of the bond completely. In most cases it makes sense to sell these bonds and replace them with more advantageous alternatives.

T1135 reporting could be significant to prepare if the investments remain in the US

I write a lot about T1135 foreign asset disclosure reporting on this blog and you can find those articles here. I won’t go into great detail on T1135 reporting for US investment accounts other than to explain why your US investments should be reviewed for T1135 purposes before entering Canada.

Canadian tax residents are required to report their non-Canadian investments on a T1135 foreign disclosure forms to the Canada Revenue Agency in cases where the cost of their non-Canadian investments exceed $100,000. Assuming the cost of your assets exceed $250,000 CAD you will not have the ability to report using the “simplified” method. Canadians have 2 choices for reporting using the “complex method” depending on whether or not their US investments are held in a Canadian or US investment account. If the US investments are held in a Canadian investment account the individual will be able to report the US investments on a country by country basis:

However, if the US investments remain in a US investment account each individual security will need to be reported separately. Not only that, but you’ll need to report the year-end and highest cost of each of the investments. The reason this would not only be terribly time consuming and difficult to accomplish is because investment accounts rarely provide reporting for “highest cost amounts” for individual investments. As you can see from the potential T1135 challenges above, moving your US investments to Canada makes a lot of sense.

Foreign exchange issues need to be reviewed

If you’re moving to Canada from the US most of your investments are likely in US dollars. After you move to Canada most of your spending needs will likely be in Canadian dollars. Proper planning for how you intend on converting currencies is crucial.

If you attempt to convert large sum of USD to CAD at traditional bank rates you’re likely paying way too much of a spread compared to spot currency rates. Foreign exchange rates offered by large banks are almost always much less favourable than the actual spot rates available in the market. Rather you’ll want to work with your cross-border investment advisor to find solutions that will allow you to exchange your USD for CAD at much more efficient rates when it comes time to converting your money.

US dividends and US capital gains distributions do not have the same preferential treatment in Canada than they do in the US

Depending you how high your overall income is, US dividends will be taxed between 0% and 20% for US purposes (also including NIIT if applicable). For Canadian purposes these dividends are treated as straight forward income fully taxable for Canadian purposes. Although you will receive a foreign tax credit for up to 15% on taxes paid to the US on these dividends you’ll pay your average Canadian tax rates on this US sourced income.

In some cases it makes sense to review re-balancing these US dividend holdings to Canadian dividend holdings to take advantage of preferential Canadian tax rates. Canadians enjoy a reduced rate of tax on dividends from Canadian public corporations. Often much less than their average Canadian rates. The difference between these preferential tax rates on dividends from Canadian public companies compared to those of the US can be significant especially on portfolios that are heaving weighted to dividends stocks.

Capital gains distributions from US funds are taxes as capital gains at rates similar to US dividends above. For Canadian purposes these capital gains distributions are not considered actual capital gains, but rather, fully taxable income. In most cases this significantly reduces the advantage of owning these funds as the distributions will be fully taxable in Canada and not at a 50% inclusion rate like regular capital gains. Reallocating funds to investments that produce Canadian capital gains distributions is often a very efficient tax strategy.

Lots of capital gains transactions in a portfolio can be difficult to manage

It can be difficult for most taxpayers to understand how challenging US/Canada capital gains transactions can be if they haven’t yet experienced filing on both sides of the border.

When Americans move to Canada they are required to report income in each respective country’s currency. Income needs to be reported in USD for your 1040 income tax return and CAD for your T1 income tax return. This means that capital gains transactions also need to get converted. Your Canadian capital gains need to be covered to USD and your US capital gains need to be reported in CAD.

On the surface it might seem as easy as converting at the average exchange rate for capital gains realized in the year. Unfortunately it’s not that easy.

For example, if you purchased a US stock for $50,000 and sold it many years later for $100,000 your US capital gain would be $50,000 USD. However you Canadian converted capital gains would not be the $50,000 multiplied by the average exchange rate for the year. Rather you’re actual Canadian dollar capital gain on the US stock sale would be as follows:

• Calculate your Canadian proceeds by multiplying your US proceeds by the exchange rate on the day of sale
• Calculate your Canadian cost basis by multiplying your US cost basis by the exchange rate on the day of purchase.

Depending on how long ago you purchased the stock and how much the exchange rate has fluctuated during that period the actual Canadian dollar gain will be much different than the net gain exchanged at the average rate for the year or the rate a the time of sale.

As you can imagine, if you have a significant amount of capital gains transaction in the year the tracking at tax time for these transactions would be time consuming and expensive. Often re-balancing an investment accounts to reduce the amount of transactions is a great way of accomplishing this. You’ll want to ensure however that this planning is done well before you become a Canadian tax resident.

Conclusion

As you can see from the items above a proper review of your US portfolio is important to ensure optimal tax and investment results. If you need helps in reviewing your portfolio before moving to Canada please reach out and I would be happy to help. I can be reached via phone/text at 250-661-9417 or via email at phil@philhogan.com.