The tax implications of a Canadian owning property in the United States
Over the past number of years, it has become increasingly common for Canadians to purchase U.S. vacation home properties. Although purchases of U.S. property by Canadians might be less likely in the foreseeable future due to the nosedive of the Canadian dollar, it is important for existing Canadian owners to be aware of the implications of U.S. property ownership, particularly on death. This article is only a very general overview of some of the rules that affect Canadians owning U.S. vacation property. Note that this article does not deal with rental income, attribution or U.S. tax filing issues.
Where a Canadian resident (non-U.S. citizen) passes away owning U.S. situs property, their estate will be subject to U.S. estate tax. U.S. estate tax is based on the fair market value of assets at the time of death and the top rate is currently 40 per cent.
There is an exemption (called the “unified credit”) approximately equal to the tax on a $5.43 million estate for 2016, but the unified credit is pro-rated for non-U.S. persons based on the ratio of the value of the U.S. situs assets to the value of the person’s worldwide assets. It should be noted that the value of life insurance policies controlled by the deceased will be included in the value of their estate for U.S. purposes, even if their estate is not the beneficiary—this can have significant implications for the determination of the amount of the unified credit available.
Estate taxes may be deferred until the death of the survivor of a married couple where property is transferred to the surviving spouse, but if the surviving spouse is not a U.S. citizen, the deferral is only available if the property is transferred to a “qualified domestic trust” (“QDOT”). However, for Canadian spouses owning U.S. real property, there is a marital credit available under the Canada-U.S. Tax Treaty which effectively doubles the prorated unified credit available. It should be noted that the marital credit is only available if the estate foregoes the deferral that would be available through the use of a QDOT.
Where U.S. property is held jointly, with right of survivorship, 100 per cent of the value of the property could be included on the death of each joint tenant unless it can be shown that the surviving spouse contributed financially to the purchase of the property. In the majority of cases, it is far preferable to have spouses own U.S. real property as tenants-in-common (although this may result in the requirement to obtain probate of the will of the first spouse to pass away in order to transfer his or her interest in the property to the surviving spouse). Significantly, a discount may be applied to the value of the deceased’s interest in the property when a fractional interest is valued and this may result in an even lower value of the deceased’s interest in the property for estate tax purposes.
It may be possible to obtain non-recourse financing of the U.S. real property to reduce the value of the property on death. It may also be possible to deduct the interest payable on the loan for Canadian purposes if the borrowed funds are used to generate taxable income (i.e. in an investment portfolio).
In many cases, insurance is obtained to pay U.S. estate tax on death. Ownership of this insurance should be carefully considered to avoid its inclusion in the worldwide estate for purposes of calculating the unified credit.
Where U.S. vacation property is owned by a Canadian corporation, there may be shareholder benefit issues for Canadian tax purposes under section 15 of the Income Tax Act (Canada) resulting in imputed rent being included in the taxable income of the shareholders of the corporation. In addition, U.S. corporate income tax rates are in general much higher than those applicable to individuals so a sale of the property by the corporation could result in significant capital gains tax.
It is common to establish a Canadian trust to own U.S. vacation property, but it should be remembered that such trusts are deemed to dispose of their property every 21 years, resulting in Canadian capital gains tax. These trusts should only be established with proper Canadian and U.S. tax advice and the trust itself must acquire the real property—i.e. the trust must be established prior to the purchase, because if the U.S. property is transferred to a Canadian resident trust, U.S. gift tax will apply. Further, it is important to ensure that expenses with respect to the property are paid by the proper parties to avoid negative tax consequences in both the U.S. and Canada.
Under the Income Tax Act (Canada), on death a taxpayer is deemed to have disposed of all of their property at fair market value immediately prior to death, resulting in capital gains tax (unless the property is transferred to a spouse, common-law partner or qualifying spousal trust). This will include U.S. real estate. There are credits available under the Canada-U.S. Tax Treaty where U.S. estate tax has been paid with respect to an asset on which Canadian capital gains tax is also exigible, but it should be noted that this will only offset federal Canadian income tax and not provincial income tax.
Given the complicated issues that arise with respect to ownership of U.S. property by Canadians, it is important to obtain appropriate advice from Canadian and U.S. legal and accounting professionals, especially prior to any purchase, transfer or sale of U.S. property.
Johanna C.C. Caithness is a tax partner practises primarily in the areas of taxation, corporate and commercial law, and wills and estates. You may reach her at (204) 957 8310 or email@example.com.