Overview
In the past decade, Canadians have been among the most active buyers of properties in the United States. Florida, California and Arizona have become preferred destinations for many Canadians trying to escape cold winters. However, the ownership of foreign properties often comes with added complexities and sometimes with hefty bills. Tax issues and estate planning are two important considerations when planning to buy or when already owning real properties in other countries, and in particular, in the United States.
Canadians owning real properties abroad, whether for personal use or for investment purposes, must ensure to be fully compliant with their Canadian tax filing obligations. Canadian taxpayers may be required to complete a T1135 Foreign Income Verification Statement to disclose ownership of any foreign property if the cost of such property (either any individual property or in the aggregate) is greater than $100,000 CAD.
In June of 2020, the Canadian Revenue Agency (CRA) announced a review of six years of real estate transactions in the U.S. The CRA has been trying to track down potential tax non-compliance from Canadian taxpayers related to U.S. properties. The focus has been on U.S. real estate and real property data where a Canadian resident was the owner or party to the purchase, sale or transfer. The tax audit may include "records on Canadian property transactions in the U.S., including municipal addresses, names of owners, square footage, sales histories, and property tax assessments."
For years, the CRA has been trying to find ways to enforce tax rules applicable to assets owned abroad and to find potential hidden tax revenue. It is therefore important for Canadians who own properties in the U.S., or in other countries, to be complete and accurate when filing taxes or when making plans related to their estate to avoid penalties.
Tax issues related to properties owned in other countries usually fall within one of the following categories: unreported foreign properties, unreported income, and unreported real estate sales.
The CRA generally requires Canadian residents to file Form T1135 every year to report their foreign property if the total cost exceeds $100,000. There is, however, an exception for “personal-use property.” Personal-use property is generally defined as property owned by the taxpayer and used by the taxpayer, or by a related person, primarily for personal or enjoyment purposes. For example, a taxpayer is not required to report a house or a condo if it’s solely used as a vacation home and it isn’t rented out. But if the taxpayer owns foreign commercial property, or if the residential property is rented even just for part of the year with a reasonable expectation of profit, then the details of that property must be reported on the form.
Failure to file form T1135 or incomplete filing may lead to a costly fine, even when all the income from the foreign property has been reported. The penalty is $25 per day with a minimum penalty of $100 and a maximum penalty of $2,500; however, if the taxpayer has deliberately avoided filing the required form, the penalty increases to $500 per month for up to 24 months.
Every Canadian resident is also required to report, and pay taxes on, their worldwide income. The income generated by foreign rental properties must be converted into Canadian currency and reported every year when filing a tax return. A taxpayer who owns a rental property in another country is allowed to deduct reasonable expenses incurred to earn the rental income. Further, a foreign tax credit may be available to ensure that the income from the property, which may also be taxable in the other jurisdiction, is not taxed twice. Failure to report the rental income from foreign properties may lead to a reassessment and tax penalties, even when the taxpayer has already paid taxes in the other country.
Canadians owning properties abroad must also comply with the requirement to report the sale of the property. The CRA has been looking into sales of U.S. residential properties owned by Canadian taxpayers to ensure that any capital gain is reported when filing their Canadian tax returns. Where a Canadian who owns a house or a condo in the U.S. is a resident of Canada for tax purposes, the proceeds from the sale of the U.S. property are fully taxable as either income or capital gains (depending on the facts of the situation), subject to the U.S.-Canada Tax Treaty. A foreign tax credit is generally available for any U.S. tax paid, but the requirement to report the sale persists even when the taxes have been already paid in the other country.
It is also possible for a Canadian to claim the principal residence exemption on a home located outside Canada. This may be the case where a Canadian resident taxpayer works in the U.S. for several months a year. Given that Canadian taxpayers are required to report the sale of their principal residence to the CRA, there is a requirement to report the sale of a U.S. principal residence to the CRA. A taxpayer who fails to report the sale can incur a maximum penalty of $8,000, along with disqualification of the property for the principal residence exemption.
Taxpayers who have provided incomplete information, who have omitted information, or who have not filed Form T1135 may be able to come forward and correct their tax affairs through the Voluntary Disclosures Program. An application must be voluntary, complete, and involve the potential application of a penalty. Further, the application will be considered by the CRA only when the agency has no prior knowledge of the tax owing by the taxpayer. Penalties for failure to file Form T1135 can be high, and the disclosure program allows taxpayers to bring properties or transactions to the attention of the CRA and receive relief on the interest and penalties that they will have to pay. It should be noted that the Voluntary Disclosure Program is complex and relief is not guaranteed.
Preparing a separate will for U.S. property
Tax represents only one of the concerns for Canadians owning properties abroad, especially in the U.S. Owners and their families can also face potential challenges when it comes to the administration of an estate. Accordingly, when developing an estate plan that includes property in the U.S., Canadians may want to consider preparing a separate will dealing with this property.
Some of the issues to be considered include the fact that a “Canadian” will may not comply with all legal requirements of the foreign jurisdiction to transfer the property in question. Additionally, there may be rules concerning residency of permitted executors.
For instance, you may need a resident of the U.S. or a resident of that specific state to act as executor for your foreign property. When preparing a will involving U.S. property, you may also want to address local tax laws, as the U.S., unlike Canada, may impose federal and/or state level estate tax. A properly drafted will may help minimize the impact of those taxes.
A second will may also make probate easier. Although a Canadian will may be valid in the U.S., it may still be subject to probate. Probate proceedings in some states can be especially long and costly, and they may involve steep legal fees. The process may be different in each state and a properly drafted will, reviewed by a legal practitioner in the state in which the particular property in question is located, can help address local complexities, streamline the process, and make it as cost effective as possible.
Preparing a second will can help prevent delays in the overall administration of the estate, further compliance with local laws, and avoid the common delays occurring in every legal process when dealing with foreign documents.
Despite the benefits of having a second will covering foreign real properties, there are also potential risks. A separate will for a property in the U.S. adds extra legal and administrative complexities and your lawyer should ensure that the provisions in the foreign will do not contradict or create problems with the Canadian will and vice versa. It is fundamental that both wills complement each other and only dispose of assets in that particular country. Legal advice in both Canada and in the particular U.S. state(s) in which property is located is required.
Estate planning and compliance with tax requirements are two very complex subjects, which may turn out to be even more cumbersome for Canadians owning assets in different countries. For the many Canadians who own real properties abroad, and in particular in the U.S., it is important to seek proper legal advice in order to ensure that all of their tax obligations are fulfilled and that all the assets are properly disposed of in their will.