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Canadians Investing in U.S. Real Estate
ROI can come at a tax cost
This article was originally published in French on Droit-in.com.
The US has long been a favorite destination for Canadian investment dollars. Whether you are currently invested in US real estate, or looking to buy, particular attention should be paid to the cross-border tax consequences.
The tax considerations differ depending on the particular investment – personal use real estate, direct investment in an income producing property, the acquisition of US REIT interests, etc. In each case, the tax considerations from both operations (e.g., rental income), and more importantly gain from a disposition, should be carefully considered. The US estate tax should also be considered whenever investing in US real estate.
Rents paid to a Canadian resident will, by default, typically be subject to a 30% withholding tax applied on gross rents. An election is available to pay tax at graduated rates on net income (i.e., after allowable deductions). State tax should also be considered, particularly if electing to pay federal tax on a net income basis. Many states starting point in computing income for state tax purposes is federal adjusted gross income, or AGI. If you are not electing to be taxed on a net income basis, most states do not have a withholding tax (with some notable exceptions, for example California has a 7% withholding tax applicable to rents paid in respect of property in the state).
On a disposition, by default there will be so-called “FIRPTA” withholdings of 10% of the total proceeds of disposition. A US tax return must be filed for the year of disposition to report the disposition and any gain will be subject to US tax as so-called effectively connected income, or ECI. Since Canada will also impose Canadian taxes on the sale of the foreign property, foreign tax credits for US taxes paid can typically be claimed in Canada to eliminate any double taxation. Canadian personal tax rates on gains are higher than US personal tax rates on long-term capital gain, typically resulting in a full foreign tax credit. Canadian corporate tax rates on gains are lower than US corporate tax rates on gains, frequently resulting in an excess foreign tax credit situation.
Individuals who own US real property directly or through a US entity must additionally consider the US estate tax implications. Estate tax can apply to assets of a Canadian that are situated in the US, including US real estate. The Canada-US treaty provides a pro-rated exemption to Canadian residents, which generally results in an estate tax exemption if the deceased’s worldwide assets are worth less than US$5.43 million.
Particular legal ownership structures will have specific consequences with respect to operations, dispositions and the estate tax. Frequently there is no one size fits all structure that achieves all tax and business objectives; a balancing is required. Additionally, there are knock-on Canadian consequences for certain structures such as foreign accrual property income, or FAPI, in the case of property held through a US corporation. A tailored approach is required, balancing business objectives, Canadian and US tax efficiencies and the overall heaviness and associated compliance costs of the structure.
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