USD-CAD Cross-Border Taxes

[RJVM]

My wife and I are US citizen and taxpayers. The following pending financial transactions resulting from the settlement agreement of a civil lawsuit in the Superior Court of Ontario, Toronto, Canada will require US-Canada cross-border tax reporting.

The settlement agreement requires the opposing party to pay us a sum of money as a repayment of their several years old financial obligations to us plus all our cost and expenses since 2019 (when the litigation commenced). After receiving the entire settlement amount, we will transfer the title of a townhouse (where the opposing party has been and currently living) to them for $1 and love and affection.

We expect the settlement amount to be paid to us in a couple of instalments. Both instalments are highly likely to be paid in 2025, but there is a slim chance of one payment in 2024. If the first instalment payment does happen this year, it will be deposited into an escrow/trust account with our attorney in Ontario, Canada. Our attorney will pay us only after the funds are received in the escrow account. YE holidays may delay the actual payment to 2025.

We have been told that from tax reporting viewpoint, the settlement payment can be treated as either a real estate transaction or a repayment of past due amounts.

I would appreciate a US-Canada cross-border tax expert’s guidance on the tax treatment for reporting in both the US and Canada. FYI, all our other income is from US-based sources only.

Thank you

[KarenJB]

Basically, given that for the lawsuit proceeds the other party is receiving a townhouse, it is the equivalent of a real estate transaction. The cost of the legal proceedings can be deducted as sales expense, given that part of your proceeds are reimbursement for your legal expense.

The transaction is reportable on both your U.S. and Canadian tax returns.

To prevent double taxation of foreign income in the U.S., two remedies are available to you; the foreign tax credit or the foreign tax deduction if you itemize deductions. 

You claim the foreign tax credit with Form 1116; you will receive credit for the amount of U.S. tax that the foreign income generated, not the foreign income tax actually paid. For more details on how the credit is calculated and for help deciding which choice is best for your tax situation, please see Foreign Tax Credit – Choosing to take credit or deduction.

I hope the above is helpful. Congratulations on finally settling this matter!

[KarenJB]

My apologies, I forgot to mention, given that this is in essence a real estate transaction, you can also deduct basis in the townhouse; that is whatever you originally paid, any amount spent on capital improvements, less any deductions taken for depreciation assuming it was rental property.

T