Question: I am a US resident and my parents back in Canada left some property for me in Canada when they died in early 2015. I just sold the property seven months after inheriting it. What are the tax consequences of inheriting and selling this Canadian property?
Answer: You will potentially need to report the inheritance to the IRS on many different forms and you may have a capital gain transaction when you sell the property.
IRS Form 3520 Part IV on Page 6 is used to report foreign inheritances/ canadian and us tax returns in excess of $100,000. In computing the $100,000 threshold, you would consider your parents as one because they are married. For example, if your mother left you $60,000 in cash and property and your dad also left you $60,000, the inheritance would be reportable. While the inheritance is reportable on Form 3520, it is not considered income and you do not have to pay U.S. income taxes on the value of the property in most circumstances. An exception would be if your parents left you some form of income such as a rental property.
You may also have to disclose your foreign estate interest on Form 8938 or at least file that form and refer to your Form 3520 filing. If you received cash or securities in a foreign financial account in excess of $10,000 at any time during the year, you may also need to file FinCEN Report 114, or foreign bank account report (FBAR). The penalties are steep for not complying with the disclosure requirements.
A Form 8621 may need to be filed for inherited Canadian property that qualifies as a Passive Foreign Investment Company (PFIC), for example non-registered Canadian mutual funds or shares in a Canadian corporation that is mainly invested in passive holdings and/or generates passive income. The rules for dealing with inherited PFICs are very complex and beyond the scope of this article.
Lastly, the sale of the property may need to be reported on Schedule D of your Form 1040. The rules of inheritance that apply to domestic inheritances apply similarly to foreign inheritances. Specifically, your basis in the assets that you inherit is stepped up to the date of death value. In other words, you would use the fair market value at the date of death of your parents as your cost of the property that you sold, and that should be reported on Schedule D. Therefore, if the property was sold for a value greater than the market value determined on your parent’s death, capital gains rates will apply.