Tax implications for Canadians purchasing U.S. real estate

The TaxLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

With U.S. real estate prices remaining near historic low levels, many Canadians feel this is continues to be an ideal time to purchase a vacation home or investment property south of the border.

More than the purchase price needs to be right, say Canadian tax advisors, who caution Canadians to also consider how they will structure their purchase and its tax implications before signing any purchase agreement.

“Canadians can simplify a lot of tax and legal issues associated with owning U.S. real estate by buying the property through a Canadian trust or other Canadian or U.S. entity rather than making the purchase in their own names,” says Chartered Professional Accountant Mark Serbinski of Serbinski Partners PC, Chartered Accountants in Toronto. “But beware. Not all of these structures work well for Canadians from a tax perspective.”

Mr. Serbinski says it is important that Canadian purchasers of U.S. real estate have an advisor who understands both the Canadian and the U.S. rules when it comes to structuring such a purchase.

Many U.S. real estate lawyers recommend buying properties intended for rental purposes through a Limited Liability Company (LLC).

LLCs are inexpensive to set up and, since they act as corporations, they shield their owners from any personal liability connected with their rental property.

Unfortunately, they create tax problems for Canadian owners who may end up paying taxes on their rental income twice – once in the United States and, again, in Canada.

Generally, Canadians must declare income earned from U.S. real estate on both a U.S. income tax return and their Canadian income tax return.

The Canadian Income Tax Act and the Canada-U.S. tax treaty can protect them from double taxation, since the taxes they pay in the United States can be credited against the taxes owed on the same income in Canada.

However, things can get complicated when different entities pay tax on the same income because those credits aren’t transferrable – the individual or entity claiming a credit in Canada must be the individual or entity that paid the taxes in the United States.

Under U.S. law, LLCs are “flow-through” entities, meaning they don’t pay taxes. Instead, any taxes owing are paid by the LLC’s owners, who declare them on their personal income tax returns. Canada, on the other hand, views an LLC as a corporation, which is liable for its own income taxes.

Because Canada and the U.S. do not recognize the tax entity as being the same, there is a risk that the owners will be taxed in both the U.S. and Canada.

A better option for Canadians is a Limited Liability Partnership. LLPs provide their owners with the personal liability protection of an LLC and, since they are treated as the same entity for tax purposes in both the U.S. and Canada, they won’t prohibit their owners from claiming credits on their Canadian income tax returns for the U.S. taxes they have paid.

Another popular way for Canadian couples to buy a U.S. vacation property is through a trust. In Canada, when one spouse dies, ownership of their property can be transferred to the surviving spouse with no tax consequences. That rule doesn’t apply to U.S. property owned by non-U.S. residents.

“Since the trust doesn’t die when one of its owners dies, it can enable the surviving spouse to maintain ownership of the U.S. property without any tax consequences,” Mr. Serbinski says.

Canadians may be liable for U.S. estate taxes if they die owning U.S. real estate, though the way those taxes are calculated differs from Canadian rules that apply to the deemed disposition of assets on death.

In Canada, taxes are applied to any accrued capital gains earned on vacation and investment properties that are not considered to be the owner’s principal residence. In the U.S. taxes are levied based on the property’s fair market value at the time of death.

The good news for most Canadians, however, is that they may not actually have to pay any U.S. estate taxes, says Chartered Professional Accountant Jamie Golombek, Managing Director, Tax and Estate Planning at CIBC Private Wealth Management in Toronto.

“Currently, U.S. federal estate tax applies to estates that are greater than $5.25 million,” Mr. Golombek says. “But that exemption applies only to the estates of U.S. residents.

Canadians who are not U.S. citizens would have to prorate the exemption by the ratio of their U.S. assets to their total worldwide assets.

Unless the Canadian’s estate has a worldwide value of more than $5.25 million, however, his or her U.S. real estate holdings will likely be fully exempt from U.S. estate taxes.”

Where Canadians will need to pay U.S. taxes is on the rental income earned from a U.S. property, and these taxes can be significant. The U.S. levies an immediate 30 percent withholding tax on the gross amount of any rent paid by a U.S. tenant to a Canadian owner.

Mr. Golombek says Canadians can opt for a special election to file taxes on a net basis, which allows them to take into account mortgage interest, maintenance costs, insurance, property taxes, any fees paid to a property management firm and other costs.

Although that takes a bit of work – people may need the assistance of a tax advisor and will have to file a U.S. tax return – the net amount of rental income will be taxable at marginal rates, which are a often lot less than the 30 percent withholding.

When deciding their options for purchasing U.S. real estate, Mr. Golombek says the simplest, most tax-effective solution may be not to buy at all.

“If your objective is to have a vacation property to use for two or three months a year, it might make better sense to rent,” he says.

“A lot of U.S. landlords will allow people to rent the same property, year after year, and many even let long-term return renters store their belongings.

Unless you intend to use the property a lot more frequently, or you feel there is a huge capital gains opportunity, renting may be the easier solution.”


Source: The Institute of Chartered Accountants of Ontario.


The TaxLetter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

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