Over the last couple of years, because of favourable real estate prices, many Canadians have shown an increased interest in purchasing real estate in the U.S. However, with this purchase comes a lot of potential tax issues that the Canadian tax payer should be aware of.
The first biggest issue to be aware of is that as of January 1, 2013, the exemption level on estate tax for owners of U.S. property drops from $5 million in worldwide assets to $1 million. Many Canadians feel that their worldwide income is still below this $1 million dollar threshold. However, you need to take into account that you must also include the value of items such as your RRSPs and life insurance payable at death. This pushes some people into the tax zone when they previously thought of themselves as safe.
There have been various tactics explored by Canadians when facing the issue of taxes on their property in the U.S. Let’s take a look at a few:
1) Having property owned by a holding company instead of being owned by an individual.
When dealing with a large estate, it may be beneficial to have a holding company own the purchased property in the U.S. This can shift the tax burden from your own personal T1 tax return to a corporate T2 tax return. However, it is important to ensure that this is the most beneficial option for your situation. For example, if you are renting out your properties and collecting income from the rent it may make you susceptible to double taxation. Corporations must pay tax on the profits of the rental income and if you wish you pay yourself a dividend from the profit of that rental income, it will be taxed again in as personal income. However, since the money will stay with the corporation until the corporation pays you as an investor, you have the ability to take out more or less each year as a way of controlling the flow of income available for taxation.
2) Owning property as an individual is much less complicated than having a holding company owning U.S. property and usually the way to go when you own a smaller estate and/or do not rent out your property. If you do rent out your U.S. home and have the ownership under your personal name, you will be subject to a 30% withholding tax for the rental income. The home owner should file a U.S. tax return with the election to pay tax on the net rental income. When this is done, the home owner will receive a tax refund in the amount of the withholding tax that exceeds the tax payable on net rental income. Furthermore, The Canadian property owner needs to provide the tenant with form IRS 4224 to avoid deduction of 30% withholding tax.
3) Giving property to a family member as a gift.
Canadians who give U.S. property to relatives are liable for U.S. gift tax as well as Canadian capital-gains tax (determined using the fair market value). A holding company is usually a better road to go in comparison because the trust doesn`t die with the person so you may be able to avoid the estate tax.
Beyond determining the method of ownership of the home, there are other key factors that the Canadian home owner should be aware of. Here are a couple of them:
1) Selling property in the U.S.
When a Canadian resident sells any property that he owns within the US, the Foreign Investment in Real Property Tax Act-1980(FIRPTA) mandates a 10% withholding tax on the gross sale price. However, it is possible to offset this tax against US income tax payable on any capital gain on the sale. A refund can be claimed if the withholding tax is above the tax liability.
This provision is subject to two exceptions.
a) When the property is sold for less than $300000 and the purchaser intends to use it for his principle residence for at least 50% of the time for the next two years he pays the full price to the seller instead of withholding 10% to remit to the IRS.
b) When the seller obtains a withholding certificate from the IRS stating that US tax liability is expected to be less than ten percent of the sale price. The amount of tax to be withheld, if any, would be mentioned on the certificate.
the United States the purchaser of a property is required to withhold 10% of the purchase price to be forwarded to the IRS to cover possible capital gains tax. If the tax owed to on the gain is less than the amount withheld you may file Form 8288-B in advance of the closing date to have the withholding taxes reduced to the actual taxes owing. Form 8288-B must be forwarded to the IRS on or before the date of the transfer of the property and the purchaser must be informed that the seller has applied for a lower withholding rate. If the application to reduce the withholding tax is approved the IRS will issue a withholding certificate. The buyer must withhold 10% of the selling price in trust until the seller receives the withholding certificate. The purchaser then has 20 days to pay the seller the amount withheld in excess of that required by the IRS.
If the tax owed is more than 10% of the selling price the seller must forward the balance owing to the IRS within 22 days of the closing date of the sale.
The IRS generally responds within 90 days to applications to reduce the required withholding amount. To ensure an efficient closing date the 8288-B ideally should be filed 90 days prior to the sale closing date. If the seller fails to file the necessary documentation with the IRS by the closing date the purchaser is required to forward the entire amount withheld to the IRS. The seller must then apply to receive the excess amount by way of tax refund.
Canadian residents intending to sell residential property in the United States should be aware the each state has similar and parallel laws that are not necessarily consistent state to state. The IRS does not act as a tax agent for individual states and each state must be dealt with individually according to the particular regulations applying to that state.
2) U.S. estate tax in case of death.
A U.S. estate tax return must be filed if a deceased Canadian resident who is not an American citizen owned U.S.-situated assets exceeding $60,000 fair market value at death. However, if the deceased made substantial lifetime gifts of U.S. property, a U.S. estate tax return may be required even if the U.S. assets do not exceed $60,000 at the time of death.
The big issue when thinking about the estate tax in the U.S. is determining the value of world-wide assets. As mentioned at the beginning of the article, the estate tax drops from 5 million to 1 million next year so any Canadian home owner in the U.S. needs to determine how to calculate the world-wide assets of the estate. These include:
a) Proceeds of insurance on the deceased life, generally including proceeds received by beneficiaries other than the estate
b) Full value of the property the deceased owned at the time of death as a joint tenant with right of survivorship, unless the surviving spouse is a U.S. citizen, in which case only half of the value is included
c) Property the deceased and a surviving spouse owned as community property
d) Several kinds of transfers the deceased made before death
e) Certain annuities to surviving beneficiaries
f) Property in which the deceased either held a general power of appointment at the time of death, or used or released this power in certain ways before death
Essentially, what this article is trying to say is that there is a lot to consider in regards to owning property in the U.S. We recommend that you discuss your options with your lawyer or accountant before making any major decisions on how to handle your U.S. property.