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If you are a Canadian who intends to purchase or who has already purchased real estate located in the U.S., you need to be aware of the U.S. and Canadian tax issues related to owing U.S. real property. Generally, the first question that arises is: In what manner should the property be held?
How you choose to structure will depend on the purpose of the property. Will it be for personal use only, or as an investment which will generate rental income, or perhaps a mix of both? What is the intended holding period? Is your intent to create a legacy asset that is passed to future generations?
Ownership in your personal name is typically a first choice for many Canadians. This is the most straightforward option and the tax treatment upon sale may also be advantageous compared to other forms of ownership. Other options include ownership through a corporation, partnership or trust. Many buyers relying on information available on the internet or on advisors south of the border, recommend holding U.S. real estate through a Limited Liability Company (LLC). As a Canadian resident, this is generally not the best choice as it can result in double taxation, with income tax rates up to 70 percent.
Regardless of the reason for purchasing U.S. real estate, it is important to seek professional tax and legal advice in advance of your purchase, as restructuring after purchase can be very costly.
One significant disadvantage of holding U.S. real estate directly is the possible exposure to U.S. estate tax. The U.S. maintains the right to levy estate tax on Canadians, who at the time they die, own certain assets located in the U.S., called “U.S. situs assets”. U.S. situs assets include U.S. real estate, shares in U.S. companies, and tangible property located in the U.S. Domestic law in the U.S. provides a basic exemption of US$60,000 for non-residents of the U.S. In addition, the Canada-U.S. Tax Treaty allows Canadians an exemption equal to that of U.S. citizens (US$11.7 million). For Canadians, estimating one’s exposure to U.S. estate tax requires some calculation. As a general rule, if your world-wide assets exceed US$11.7M and you own U.S. situs assets you may be subject to U.S. estate tax. In turn, properly structuring the purchase of U.S. real estate will be a key consideration in order to avoid U.S. estate tax.
If you are about to receive income from a U.S. property, or are selling U.S. real estate, non-residents of the U.S. are required to obtain an Individual Taxpayer Identification Number (ITIN). Applying for the ITIN is not onerous, however the application process and required documents that accompany the application is often confusing.
If you intend to earn rental income from your U.S. real estate, you will be subject to U.S. income tax on the rental income received. There are two choices in this respect: (1) a withholding tax of 30 percent of gross rental income is withheld and remitted to the IRS (i.e. no deduction for expenses), or (2) make an election to file a non-resident U.S. tax return and pay tax at graduated rates on net rental income (deduction for expenses allowed). Note that as a Canadian resident, the rental income must also be reported in Canada with an adjustment for foreign exchange.
Similarly, when you or your Canadian entity sells the U.S. property, you are required to report this on a U.S. federal tax return (and a state tax return if the state in which the property is located levies income tax) and must also report in Canada with an adjustment for foreign exchange. As an example, if you purchased U.S. property in the year 2010 for US$500,000 and sell today for US$600,000, the gain for U.S. purposes is US$100,000 (ignoring selling expenses). However, the reporting on the Canadian tax return will be a gain of about CDN$300,000 as the exchange rate in 2010 was about 1.00 and today it is about 1.32 (1 U.S. dollar = 1.32 Canadian dollars). To avoid double taxation, Canada allows a foreign tax credit for U.S. taxes paid on the rental income or gain from sale of U.S. real estate. In the example, Canada would generally allow a foreign tax credit for all the U.S. tax paid.
At the time of sale, the U.S. requires the purchaser to withhold 15 percent of the selling price and remit this to the IRS. This federal withholding tax may be reduced to 10 percent or even completely eliminated in certain circumstances. In addition, some states require their own withholding tax (California and Hawaii are notable examples).
If you have questions about the U.S. and Canadian tax issues related to purchasing and maintaining U.S. real estate, we are here to help. Contact David Cender, CPA, CA, CPA (Illinois), Partner, International Tax Services, MNP at 604.542.6716 or
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Related Topics:Personal Tax; U.S. Tax; Property; International Tax; COVID-19
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