Blog post

Key Points

• The Tax-Free First Home Savings Account (FHSA) offers Canadian residents tax-free savings for their first home purchase.
• U.S. citizens in Canada may face U.S. tax reporting and potential taxation on FHSA contributions and earnings.
• The FHSA is not recognized under U.S. tax law, leading to possible complications for American expats in Canada.
• Careful planning is needed to navigate the cross-border tax implications of using an FHSA as a U.S. citizen in Canada.
• Consulting with a cross-border tax advisor is crucial to optimize the benefits of an FHSA while complying with U.S. tax obligations.

If you need help in reviewing your cross-border tax or investment situation, please feel free to reach out to us here. We look forward to speaking to you soon.

There has been lots of chatter in the Canadian financial press about the new Tax-Free First Home Savings Accounts (FHSA) that are currently being rolled out throughout Canadian financial institutions.

Before we dive into why and how these new type of accounts can work for Americans living in Canada let’s walk through how these accounts actually work:

What is the Tax-Free First Home Savings Accounts (FHSA)?

A tax-free first home home savings account or FHSA is a new type of account that allows first time Canadian home buyers to save in a tax efficient manner for the purchase of their first home.

How does the FHSA work?

First time home buyers are able to contribute up to $8,000 a year to the account up to a maximum lifetime contribution of $40,000.

In order accumulate the annual $8,000 contribution limit you’ll need to open a FHSA account. if not, no contribution room will be created.

Any contributions to the account will be fully deductible, all the income earned internally will be tax-free and any subsequent withdrawals from the account for downpayment purposes will also be tax-free.

The FHSA combines the benefits of both RRSP and TFSA accounts.

Who is eligible for a FHSA?

In order to be eligible to open a FHSA you’ll need to be:

• A Canadian tax resident
• 18 years or older
• You also need to be a “first time home buyer”

What else should I know about opening an FHSA?

• You can hold the same type of investments in the FHSA as in RRSP or TFSA accounts
• You are not required to deduct any contributions to your FHSA and can carry them forward to future years
• Each year the account is opened you’ll receive $8,000 of contribution room that carries forward to future years (up to a max of $40,000)
• Contributions to your FHSA will not impact your TFSA or RRSP contribution limits
• If you don’t use the funds in the FHSA to purchase a home the funds will be taxable upon distribution

Now that we’ve explained how the FHSA works for Canadians let’s walk through how these type of accounts can work for Americans in Canada.

As most of you know already many Canadian investment and registered plans have certain challenges for American taxpayers. For example, TFSAs are not tax-free for US tax purposes and some argue they also trigger 3520 filings requirements.

So, how are FHSA accounts treated for Americans in Canada?

The honest answer is that until the IRS opines on the new FHSA accounts we won’t know for certain how these accounts are treated for US tax purposes.

That being said, based on how similar accounts (TFSA, RRSP and RESP) are treated we can make some informed assumptions.

First, if we make the assumption that these new accounts will not be considered foreign trusts for US tax purposes (if they are additional requirements such as 3520s will need to be reviewed) the impact for US tax purposes should be relatively straight forward.

IMPORTANT:

Once again, these accounts are very new and Americans thinking of opening up such accounts should be aware of the possible risks associated with opening accounts that have yet to be reviewed or challenged by the IRS.

Now that we got this “warning” out of the way let’s discuss now these new FHSA accounts can work for Americans in Canada.

Subsequent to the announcement of these new investment savings accounts I received a fair amount of questions from my America clients. These accounts seem to be a great idea for Canadian tax purposes, however, will they work for Americans living and filing taxes in Canada?

Let’s take a look at a case study to illustrate how this might look:

• Maria, a 25 year old American living in Canada is saving for her first new home and is considering opening up a Canadian FHSA account
• She currently makes $100,000 a year at an average tax rate of 25% Canadian and 20% US tax rate
• She will need 5 years to save the maximum $40,000 in the FHSA

Is she opens the account in year 1 and contributes $8,000 a year for 5 years she’ll reach the $40,000 max.

Canadian tax impact:

• Each year she will be able to deduct the $8,000 contribution against her income savings approximately $2,000 in Canadian tax or $10,000 on the total $40,000 maximum.
• All the income earned in the plan will be tax-free
• If distributed to purchase a first time house the full amount of the distribution will also be tax-free

US tax impact:

• The $8,000 contribution will not be deductible for US purposes. However, similar to RRSP contributions this will not affect overall taxes owing
• Assuming the account is not considered a foreign trust it will be considered a regular investment account for US purposes
• The highest balance in the account should be reported on her FBAR and 8938 if applicable
• Any income or capital gains earned in the account will be taxable in the US
• Future distributions from the account will be tax-free as capital distributions in the US (just like regular investment accounts)

As with most things “cross-border” we need to review both the Canadian and US tax implications together to assess whether setting up such an account is ultimately beneficial to the taxpayer.

As you can see from the outline above the main issue is the taxation of the income for US purposes. The income earned in the plan is tax-free for Canadian purposes, but taxable for US purposes.

Even with these challenges we have some options:

• If Maria has form 1116 passive foreign tax credit carryforwards she will be able to earn passive Canadian investment income within the FHSA and not pay any additional US tax
• If she doesn’t have any available 1116 carryforward credits she might consider putting the FHSA contributions into investments like growth ETFs that don’t distribute any investment income
• Now, once the accounts are liquidated she might have a taxable gain the investment that will also be taxable in the US, but at much lower rates. Even if she doesn’t have 1116 carryforward credits she will still be quite ahead given the 25% tax savings on the contributions above

As we’ve seen in the last 15 years many young Canadians obtain downpayment capital from their parents. Would this still work if Maria was gifted the $8,000 amount each year from her parents?

The simple answer is yes.

Even if he parents were American the $8,000 annual gift would be below the annual US gifting amount and the parents would not be required to file a US gift tax returns. This would be much more efficient to gift through a FHSA than gift directly for a downpayment given the 25% or $10,000 tax savings outlined above.

However, because you only receive the $8,000 of FHSA contribution room if the account is opened you’ll want to ensure that your adult child opens the account as soon as possible. Also, you’ll want to contribute each year even if your child does not want to use the deduction as it will carryforward to future years.

Once again, I can’t emphasize this enough. The FHSA account is very new and has not been subject to any scrutiny from the US tax department. As an American living in Canada make sure to obtain advice from a competent cross-border advisor before opening a Tax-Free First Home Savings Account.

If you have any questions on this topic or any other cross-border tax or investments topics feel free to email at at phil@philhogan.com and I’ll do my best to help.