What is the 871(d) net election for Canadians with US rental property?

Why the default rule taxes 30% of your gross rent

Without an election, the IRS treats rent paid to a Canadian owner as passive US-source income and taxes it at a flat 30% of the gross amount, with no deductions at all. The tenant or property manager is the withholding agent: they must hold back 30% of every rent cheque, send it to the IRS, and report it to you on a Form 1042-S. The Canada-US tax treaty does not lower this rate, because Article VI leaves the taxing of real property income with the country where the property sits.

The arithmetic is harsh. A condo that brings in US$24,000 of rent a year loses US$7,200 to withholding even if mortgage interest, condo fees, property tax and repairs eat up most of that rent. Owners who are barely breaking even can end up paying more US tax than they earned.

What the 871(d) election changes

Section 871(d) of the Internal Revenue Code lets a non-resident alien elect to treat income from US real property as effectively connected with a US trade or business. Once you make that election, the rent is taxed the same way a US landlord's rent is: you report gross rent, subtract your expenses, and pay tax on the net profit at the graduated rates that apply to individuals on Form 1040-NR.

The deductions that come with the election include:

• mortgage interest, property tax, insurance and HOA or condo fees;
• repairs, utilities you pay, advertising and travel to inspect the property;
• property management fees and the accounting fees for the US return; and
• depreciation of the building portion over 27.5 years for residential property.

Depreciation is the reason many elected returns show little or no US tax. It is not optional in any useful sense: the IRS recaptures the depreciation you were entitled to claim when you sell, whether or not you claimed it, so claiming it each year is the only sensible course. If the property shows a net loss, the loss is normally suspended under the passive activity rules and carried forward against later rental profit or released when you sell.

You make the election by attaching a short statement to your 1040-NR for the first year it applies. The statement says you are electing under section 871(d), lists each US property with its location, your ownership share and when you acquired it, and describes any major improvements. The election covers all of your US real property income, not one property at a time.

How Form W-8ECI stops the withholding at source

The election fixes the tax; Form W-8ECI fixes the cash flow. By signing a W-8ECI and giving it to your tenant or property manager, you certify that the rent is effectively connected income and that you will file a US return to report it. The manager can then pay you the full rent with nothing held back. Two practical points:

1. The W-8ECI requires a US taxpayer identification number, so most Canadians need an ITIN before the manager will accept it.
2. Like the W-8BEN, it expires at the end of the third calendar year after you sign it, and it needs to be refreshed if your name, address or ownership changes.

If rent was already withheld at 30% before you sorted this out, nothing is lost. Make the election on the 1040-NR, report the net income, and claim the tax shown on the 1042-S as a payment. The difference comes back as a refund.

Why the election is binding and why filing on time matters

Once made, the 871(d) election stays in force for every later year until you revoke it, and revoking it needs the consent of the IRS. In practice nobody wants to revoke it; the point is that you cannot switch between net and gross treatment year by year to chase the lower bill.

The bigger trap is late filing. A non-resident alien who does not file a "true and accurate" return on time can lose the right to deductions and credits altogether. The IRS regulations set a cut-off that is, broadly, 16 months after the due date of the 1040-NR. File later than that and the IRS can assess 30% of the gross rent even though you elected net treatment.

For a Canadian with no US wages, the 1040-NR is due June 15 of the following year, and the safe habit is to file every year, including years when the property shows a loss and no tax is owing. Several states, including Arizona and California, also expect a non-resident state return on the same rental income.

None of this changes what you report to the CRA. As a Canadian resident you declare the gross rent and expenses in Canadian dollars on Form T776, using the right exchange rate, and claim a foreign tax credit for the US tax actually paid. Our guide for Canadians owning US rental property walks through both returns side by side.

How we handle 871(d) elections for clients

We treat the election as part of the first-year setup, not an afterthought. For a new US rental we obtain the ITIN, prepare the W-8ECI for the property manager, draft the election statement and file the first 1040-NR with it, then prepare the US return and the Canadian T1 together every year so the depreciation, the exchange rates and the foreign tax credit line up. If you have been paying 30% on gross rent for years, we review whether refund claims are still open. Our cross-border tax services page explains how the engagement works.

Source: IRS — About Form W-8 ECI.