At the end of each year, it is a good idea to review the income that you generated during the year and consider the impact that it will have on your tax return.

Depending on the year, you may have earned more or less income than normal or received a financial windfall from inheritance or severance. You may have realized significant capital gains in the current or prior years. You may have your home on the market for sale. Perhaps you own shares in a Canadian mutual fund, also known as a PFIC to those who file US tax returns.

Each of these situations should be addressed in a year-end tax plan. This can be a tricky exercise for anyone, but for an American living in Canada it becomes much more complex. The traditional advice for a Canadian does not always apply to you, and the tax rules that you may be accustomed to in the US may not hold true in Canada. Instead, you need to consider the tax rules of both countries.

Let’s take a deeper look at a few of these scenarios.

Large RRSP Contributions

As a Canadian, a great option to invest tax efficiently is within a RRSP. When you make the contribution, you get a deduction on your tax return which reduces your income for the year by an amount equal to your contribution. For as long as the investment is inside the RRSP all of the growth is tax free. When a withdrawal is eventually made from the RRSP it is taxed as ordinary income. The idea is that when you start to make withdrawals it will be after you have retired, when it is likely that you are in a lower tax bracket than you were in when you made the original RRSP contribution. If you have do not make your maximum RRSP contribution in any given year the ability to do so will be carried forward inevitably. This results in many Canadians having very large RRSP deduction limits. In the event of a financial windfall (severance, stock option exercise, sale of property, inheritance) you may be inclined to make a lump sum RRSP contribution to reduce your income dramatically in that year.

This large RRSP contribution can cause issues if you are a US citizen. By default, the IRS does not recognize the RRSP contribution for deduction purposes on your US tax return. This can result in a mismatch of taxable income in the two countries and depending on the magnitude of the RRSP deduction you may find yourself with an unexpected amount owing to the IRS.

Low Income Year – Realize Capital Gains

In an abnormally low-income earning year you may choose to trigger capital gains in your investment portfolio to take advantage of lower than normal tax rates. If you don’t want to sell the shares yet but the tax strategy is appealing to you then you can simply sell the shares and then repurchase them back immediately. There is no need to wait 30 days to repurchase the shares like there is when you sell shares at a loss. Essentially all you have done is increased the cost basis on your investment and paid the tax on the capital gain in a low-income year instead of in the future when you expect your income will be higher.

As a US citizen in Canada, you have a number of additional factors that need to be considered.

First, exchange rates are significant. On your US tax return you have to report gains and losses in US dollars. Just because you have a loss in one currency does not mean that will be the case in another currency. This mismatch could result in an unexpected tax bill.

Second, the US classifies capital gains as either short term or long term. If the holding period was one year or less, then it is considered short term and is taxed as ordinary income. Conversely, if the holding period was greater than a year then the capital gain is subject to lower tax rates that would more closely resemble the tax favoured capital gains treatment in Canada. Care and attention needs to be taken when triggering gains for this reason.

High Income Year - Tax-Loss Selling

A fairly common year-end tax planning is tax-loss selling. The concept is that you sell your investments which you have lost money on to offset the gains that you have realized on your winners. You only pay tax on the net amount of gain. In Canada if you have net losses you are allowed to carry them back to be applied against gains in any of the three previous tax years, or forward indefinitely.

For US citizens, exchange rates again need to be considered to make sure you are not accidentally creating a gain in US dollars. When creating capital losses there are further intricacies to be considered with respect to short and long term holding periods from a US perspective. Short-term capital losses will offset short term capital gains and long-term capital losses will offset long term capital gains. A short-term capital loss will only be applied against a long-term capital gain once there are no remaining short-term gains to apply them against. Similarly, long term capital losses will only be applied against short term capital gains once there are no remaining long term capital gains to apply them against. If you have a net capital loss then the first $1,500 (per person, so $3,000 for a couple) can be applied against ordinary income and the excess can be carried forward. You are not allowed to carry back capital losses in the US.

Principal Residence Listed For Sale?

In Canada you are allowed to sell your principal residence and the entire gain is tax free. It doesn’t matter if the gain is $5,000 or $5,000,000.

American’s need to be aware that the IRS only allows for a tax-free exemption of the first $250,000 USD in gain on your principal residence, even if the home is in Canada. If you are married, then this exemption can be doubled to $500,000 USD. This can create a significant and unexpected tax bill if your home has dramatically increased in value since your original purchase.

In the circumstance where a property is owned jointly, and one spouse is a US citizen, and the other is not a little foresight and planning can go a long way. In 2024, US citizens are allowed to gift up to $185,000 USD tax-free each year to their non-US spouses. This amount is indexed each year. This means that a portion of the ownership in the family home can be transferred to the non-US spouse each year. If done correctly and with enough years of preparation this strategy will eliminate the tax payable to the IRS on the sale of the home.

Canadian Mutual Funds (PFICs)

Canadian mutual funds (PFICs) can be fine investments for most Canadians but for US citizens the tax treatment can be very punitive. If you are a US citizen and you are not aware of what a PFIC is, I suggest you read this RBC Navigator document which explores PFICs in depth.

From a year-end tax planning perspective, you may want to decide whether you want to eradicate yourself from your PFIC holdings in non-registered accounts prior to the end of the year to not only avoid any further punitive tax treatment but also to avoid having to make the onerous tax filings next year.

If for whatever reason you still want to hold a PFIC and that PFIC that does not provide a QEF statement, then taking the Mark-to-Market (MTM) election is preferred to the default method. Taking the MTM election means that you will be taxed as though you hypothetically sold your fund holdings at the end of the year. The gain on the deemed disposition is taxed at ordinary rates instead of capital gains rates. The deemed disposition is of course fictional and there will be no corresponding income or tax payable to Canada so there is no chance to claim a foreign tax credit, resulting in double taxation when the fund is eventually sold (for real) in Canada. A reasonable solution to this problem would be to actually realize the gain each year in Canada by selling the fund on December 31 and then rebuying it, at least then your income in Canada and the US will match and you will have a basis for claiming a foreign tax credit.

If you have a non-US spouse, then you could they could own the PFIC in an account that is in their name only. If all of the investments are in your name then you need to be careful about attribution rules in Canada so a family income-splitting loan could be combined with this strategy. Your spouse can take the loaned funds and invest in the desired PFIC in an account registered to them solely. Assuming your US filing status is Married Filing Separate then all that you would need to report on your US tax return would be the interest paid to you by your spouse on the loaned funds.

Conclusion

Year-end tax planning strategies are important to consider and when done correctly can save you a lot of money. These strategies are complex to begin with, but when you layer multiple tax regimes with differing rules, they become much more complex and difficult to implement. As such, it is recommended that you consult professional advice when considering any of the above strategies.