It depends on their intent. Was it for investment or rental, then yes. If for a second personal resident then no. It is treated as any property purchased by a US resident no matter where property is located

Thanks Terry - intent was a remodel for a bed & breakfast, started but never finished.  Does that qualify as investment?  Clients lived there part time while fixing up. 

Sounds like a personal use asset since they lived in it.

Possibly an investment but you would need to research thoroughly.

And yes you need to use US dollars on US tax returns.

What was the Canadian tax treatment for this? I'm curious.

@sjrcpa Canada would have withheld tax on the proceeds, or the sellers might have done some paperwork before closing to show there was no gain.  In either case a return would have to be filed, but since there was no other Canadian income, a loss would have no benefit, unlike on their 1040.

If this was going to be a traditional b&b, with guests in their own home, it would be mixed personal and business use.  Or is that really a business?  Forget Canada, what if they had done this in the city of Canadian, Texas (on the Canadian River)?  Similar to the "renting to a roommate" situation, which I have managed to avoid for a couple decades.  Was it really a loss on the real estate transaction, or from the start-up expenses for the business that never started?  What do they have to show intent -- did they check on zoning and permit regulations?  Maybe bought the property and then found out the intended use was illegal?    Were they going to move to Canada, or was this just a way to offset some of the costs of their second home?  Lots of facts and circumstances to consider.  

Bob  - Thank you.  I appreciate the detail, questions, and examples.  Clients have already engaged Canadian CPA firm and attorney and I have access to their submittals.  I don't know as yet if they separated expenses between personal residential and business B&B.  That is pending. I understand 'intent' and am determining that now.  If the Canadian submittals show business expenses that would help with 'intent'.  

Prior discussion w/CPA says if there is a loss they don't have to file a personal tax return, however because there will be 'proceeds' the Canadian attorney withholds 25% - even if there is a loss!  

Appreciate the reply.  More to be revealed as I continue my research.  Also open to any suggestion - every little bit helps - it is basically a facts and circumstances exercise at this point.  I believe their original intent was a primary (not a second) residence that morphed into a B&B concept.  Just looking for the hook on which to place my hat either way.  They are allowed to take a position favorable to them supported by the their actions ... 'but for' and all that. 

By the way I encouraged clients to do the FINCEN and related forms which they did - I did not want that responsibility - and have since added that to my engagement letter.

To satisfy your curiosity re Canadian tax treatment:

From the beginning I encouraged clients to engage Canadian tax professional to help.  Even if there was no 'income'.  Reason being there may be filing requirements at local, provincial level 

Upon decision to sell the engaged Canadian CPA and attorney - CPA's do taxes - attorney handles the money - distribution and withholding.

Form sent by CPA were instructions T2062 E (21) Request by Non_Res for Cert of Compliance ... etc   with attachments for each spouse to sign and details showing Proceeds, Adjusted Cost Basis, Gain(Loss), exemptions, Net Gain Loss) and Form T1261 Application for CRA Tax Number for Non-Residents.

I got hooked up with CPAs and inquired if their submittals satisfied all Canadian obligations.  Answer: Yes, all obligations satisfied..  And that because of loss no Canadian tax return was required to be filed.  

I was informed that attorneys on behalf of CRA (Canadian Revenue Authority) with hold 25% of proceeds - even if there was a loss.  And that balance would not be released until long after 2025 US tax due date of April 15, 2026.  

   Thanks again.