I live in California and recently sold a farm (rental) property in Canada. Looking ahead to my 2023 tax filings, I know that I will have to pay Canadian capital gains tax, and I know that I will be able to claim a foreign tax credit for this (form 1116) on my Federal return. But I have no idea on how California will want to treat this. Here are the options that I see so far:
!. Claim the CDN tax as a Credit on my federal return and assume it is not allowed on my CA return. Results in low Federal tax but very high CA tax.
2. Claim the CDN tax as an Expense on my federal return, and assume it will be allowed on my CA return. Result is much higher federal tax and lower state tax.
3. Claim the CDN tax as a Credit on my federal return and claim it as an Expense on my CA return. This results in the lowest tax in both cases, but requires that I manually add the expense to my CA return as a "selling expense". Not sure that I'm allowed to do this.
4. In searching this forum I found this item (below) from ThomasM125 which seems to offer a fourth approach of paying the full CA tax, but then adding it to Form 1116 as an additional foreign tax paid. This sounds strange and I would like to further verify if its allowed.
I would really appreciate some advice on this. It has been my experience that local tax preparers are woefully lacking when it comes to foreign tax issues.
Line 1(a) of Form 1116 is where you report your foreign income. You qualify to treat the California tax on your foreign income as foreign tax paid, but the foreign income is the income from Canada, so that goes on line 1(a). The California tax paid on your Canadain income, along with your tax paid to Canada on that income, is reported in Part II of Form 1116.
