IS IT RIGHT FOR YOU
The decision to purchase US real estate may not be as easy as it seems, and there are many myths surrounding how Canadians should do so. Although there can be many benefits for Canadian residents who are looking to purchase US real estate, an unanticipated tax bite can quickly turn a sweet deal sour. It’s important to evaluate how the potential tax consequences will affect you, and consider alternatives. Below are some questions to help you determine what your next step should be.
Are you a Canadian resident (and not a US citizen) who is considering the purchase of personal-use real estate (and not rental income property)?
Yes … continue to next question
No … If you’re a US citizen, the information in this section likely doesn’t apply to you
What’s the magnitude of your exposure to estate tax?
Calculate your exposure to estate tax with the following formula:
(Value of US property ÷ Value worldwide assets computed under US estate and gift tax principles) x Exemption (i.e. tax credit). This information will be determined at the time of death.
Significant … continue to next question
Insignificant … you may want to continue to the next question or skip to the Day Count section
Do you care?
Yes … continue to the Trusts section to explore your options
No … if you’re not currently concerned about US estate tax exposure, then visit the Day Count section of this website to find out how that may affect you
Roy A Berg JD, LLM (US TAX) Director, US Tax Law, Barrister and Solicitor
Roy has more than 23 years of experience in IRS tax controversy, cross-border tax matters, estate planning, and finance. In particular:
Canada-US tax and estate planning; IRS Voluntary Disclosures; Foreign trust and reporting obligations on forms 3520 and 3520-A; Foreign entity reporting obligations on forms 5471, 5472, 926, and 8865; Foreign Account Tax Compliance Act (FATCA); and Net Investment Income Tax (NII).
PLANNING WITH TRUSTS
When it comes to owning US real estate that minimizes both US and Canadian income and estate tax, there is no “one size fits all” solution. Before purchasing your vacation home south of the border, it’s important to meet with a tax professional to explore your options.
Cross-border US real estate trust
If properly constituted and administered, owning US property through a cross-border US real estate trust will exclude the value of the property from your US taxable estate and will not result in adverse US or Canadian income and estate tax consequences. It is important to ensure drafting, funding, titling, and operating the trust is done properly, or it will not produce the desired tax benefits.
Inheritance trust for your children who are US citizens
If you’re a Canadian resident (and not a US citizen), have kids who are US citizens or reside in the US, and possess a substantial amount of wealth, then a trust might be the key to sheltering your wealth from US estate tax. If your children will inherit money and/or property from you upon your death, an inheritance trust may be an ideal vehicle for your children to receive such wealth, and may assist in ensuring they avoid potentially steep inheritance tax.
Qualified Domestic Trust
If you’re a US citizen, but your spouse is Canadian, then he or she may be required to pay US estate taxes on the property transferred at your death. Establishing a will with a Qualified Domestic Trust (QDOT) allows your Canadian spouse access to the marital deduction that’s available to US citizens, permitting you to transfer the property to them and defer the estate tax until they die.
We’re here to help. Contact us to find out more.
Kim G C Moody FCA, TEP Director, Canadian Tax Advisory
The antithesis of status quo, Kim is driven to innovate new and better ways to do things for the clients he serves, the advancement of the firm and other professionals in the tax profession. His relentless obsession with getting to know everything in the Tax Act makes him a highly sought out resource for peers and clients. And while a dyed in the wool tax geek, he has a unique ability to transform the technical details into plain English to make the information real and relevant.
DOS AND DON’TS
The tax world has changed a lot in recent years. It’s important to be aware of the vehicles that can cause potential taxation pitfalls.
US Limited Liability Companies (LLC) and Revocable Living Trusts (RLT)
LLCs are generally taxed as partnerships in the US, but are taxed as corporations in Canada. This causes potential double taxation, a “taxable benefit” for Canadian income tax purposes, and higher overall income taxes. RLTs are not necessarily ignored for Canadian tax purposes, which can also result in potential double taxation.
The Canada Revenue Agency (CRA) has not ruled on the Canadian entity classification of US Limited Liability Limited Partnerships (LLLP) and Limited Liability Partnerships (LLP), thus causing uncertainty on the Canadian tax implications of using such vehicles.
Gifting US real property
Gifts of US real estate are not eligible for pro rata unified credit utilization and are subject to gift tax at 40% of the value of the gift. In addition, the Canadian attribution rules mean you may also be subject to Canadian tax.
Joint Tenancy with Right of Survivorship
When two (or more) people own a property as Joint Tenancy with Right of Survivorship, and one of the joint tenants dies, the entire property is passed to the survivor(s), and can result in double application of the US estate tax.
Holding US real estate through a Canadian corporation can cause Canadian shareholder benefit issues, which can result in significant Canadian tax costs.
Life insurance and non-recourse debt
Life insurance can be a very simple and effective way to provide liquidity to cover your US estate tax liability arising on death. Financing the property with non-recourse debt is also an option that can reduce your US estate tax exposure.
Dale Franko CPA, CA, CPA (IL, USA), TEP Director, Canadian Tax Advisory
Dale is the proverbial duck moving through water. He looks perfectly calm on top, but the precise, purposeful activity going on under the surface is powerful. Dale subscribes to the theory that there is a solution for every problem, you just need to think smart, know your facts and employ creative problem solving. Achieving both the CA and CPA designations, his forte is a passion for comparing and contrasting the tax laws amongst various jurisdictions. He thrives on the challenge of balancing a tax solution with the business vision.
DAY COUNT RULE
Since the US and Canada enhanced the sharing of information on individuals entering and exiting the country in 2014, tracking length of stays has become much more important. It’s critical for all Canadian snowbirds to maintain an accurate record of how many days they are in the US, to ensure they aren’t affected by the following:
US income tax on worldwide income
The US taxes both their citizens and residents on their worldwide income. Canadian snowbirds will be deemed residents if they are “substantially present” in the US. If your current day count in the US in a calendar year is greater than 30, and you’ve spent a substantial amount of time in the US in the two calendar years previous, please click here for an overview of how you may be affected.
US estate tax on fair market value of worldwide assets
The US also taxes their citizens and residents on the fair market value (FMV) of their worldwide assets at death, meaning uninformed snowbirds can find their inheritance subject to US estate tax if they are domicile in the US at the time of their death. It is important to note that the “residency” rule for estate tax is different than the test for income tax.
Canadian departure tax
Canada taxes its residents on their worldwide income. Once a Canadian person is no longer resident in Canada, he or she is deemed to have disposed all assets (subject to certain exceptions), recognize the gain on those assets, and pay tax on that gain.
Banned from travel to US
Canadians who overstep the maximum days for immigration purposes can be excluded from visiting the US in the future. The period of inaccessibility can range from three years, to 10 years, to permanently.
Loss of provincial health care
Once an individual is no longer resident of a particular Canadian province, he or she may lose entitlement to provincial health care.
SELLING US REAL ESTATE
Canadians who purchased US vacation property in the past few years may find that now is the ideal time to sell, considering the interplay between rising US real estate prices and the recent devaluation of the Canadian dollar (CDN) relative to the US dollar (USD). It is also possible that Canadian capital gains inclusion and/or tax rates could rise over the next few years, therefore a gain today could be taxed at a lower rate than it would be one, two or three years from now. Before you sell your US vacation property however, consider the following factors:
DECLINE OF THE CANADIAN DOLLAR
If you didn’t borrow significantly to purchase your property, the appreciation of the greenback against the loonie, combined with the appreciation in US real estate, means you will have an even larger gain when the USD sale proceeds are converted into CDN funds.
If you borrowed US dollars to purchase the property, the decline of the CDN dollar will hurt. Although the CDN gain may be significant, the ultimate cash realized on a sale may be less than expected if any USD debt incurred to acquire the property is repaid.
PAYING TAX ON GAINS AND THE FOREIGN INVESTMENT IN REAL PROPERTY TAX ACT
The gain on sale of US real property is US sourced income, therefore the US has the right to tax the gain before Canada does, with the resulting gain and corresponding tax liability being determined in accordance with US income tax legislation. The Foreign Investment in Real Property Tax Act (FIRPTA) may also apply, requiring the purchaser to withhold and remit 10% of the selling proceeds to the IRS for transactions under $1M USD and 15% for transactions over $1M USD.
As a Canadian resident, you are liable for tax on your worldwide income, which includes any gain on the sale of US real property. Accordingly, the CDN equivalent gain will be taxable in Canada (likely as a capital gain) and Canadian federal and provincial income taxes will apply (the Canadian Tax Otherwise Payable). However, in an attempt to avoid double-taxation, Canada has a foreign tax credit (FTC) regime to allow a FTC (or deduction) to be claimed against the Canadian Tax Otherwise Payable.
The sale of US real estate owned by a cross-border trust may result in a gain being realized by the trust for both US and Canadian income tax purposes. The Canadian “attribution rules” may also apply in respect of the gain, so caution must be exercised before any income tax returns are filed.
The rules that apply to Canadian resident individuals, partnerships, or trusts are similar to a Canadian corporation in respect of the calculation of the gains (US and Canada) and the application of FIRPTA. However, the resulting overall tax burden (US and Canada) including potential taxable benefits, significantly impact the after-tax cash flows from the sale of real estate owned by a Canadian corporation.
Moodys Gartner Tax Law is here to help you weigh your options. Contact us to find out more.