A recent Financial Post article states that “one in five Canadians are now eyeing the U.S. [housing] market”, considering potential investments in U.S. real property. This shift in focus, of course, is largely value driven, as the median house price in the U.S is now $156,100, having dropped more than 30% from the previous peak established more than four years ago. (i) Add a strengthening Canadian dollar to the equation, and Canadians, it would appear, smell a bargain.
And while a move into U.S. real property at historically devalued levels may very well present a powerful purchasing opportunity, it also presents a series of tax liabilities that potential purchasers would do well to carefully assess prior to making an acquisition. Some liabilities, such as the application of property tax or other municipal levies are to be expected. Others, such as the potential impact of U.S. income tax or U.S. estate tax may provide unwary buyers with a painful surprise.
In brief, the purchase of U.S. real property can expose a Canadian purchaser to a wide array of U.S. taxation, such as U.S. income tax or estate tax, depending upon the particulars of the Canadian purchaser's situation. Although the consideration of U.S. income tax is beyond the purview of this article, Canadian taxpayers should note an exemption may be provided by the Canada – U.S. Tax Convention, so long as the Canadian purchaser maintains stronger ties or social connections in Canada (such as their primary home and family) than in the U.S.
While U.S. income tax may be understood as presenting a relatively concrete risk and tax liability, the potential application of U.S. estate tax, by comparison, presents an entirely separate order of risk. To substantiate this statement, it is important to understand both the scope and current lack of certainty regarding U.S. estate tax. As a starting point, this tax may be understood (from a Canadian perspective) as a tax based on the total amount of a non-resident’s U.S. situs assets, whereas most taxes merely tax the difference between a taxpayer's adjusted cost base (what they paid for it) and the fair market value of an asset. Further, as a result of Congress being unable to agree upon the ideal structure of this tax, U.S. estate tax has morphed from being inapplicable (2010) to applying to U.S. assets in excess of $5,000,000 at a tax rate of 35% (2011 and 2012) to applying to U.S. assets in excess of $1,000,000 at a tax rate of 55% as of January 1, 2013 (subject to any possible future amending legislation from Congress).
It is important to note that the exemption amounts outlined above represent the exemption afforded to each American citizen. They are not automatically applicable to Canadian residents. Instead, a Canadian resident must apply under the Canada – US Tax Convention for a prorated portion of the US exemption ($1,000,000 as of January 1, 2013), such amount being calculated as the value of a Canadian resident’s U.S. property divided by the total sum of the Canadian resident’s total net worth, multiplied by $1,000,000).
Thus, while the current exemption amount of $5,000,000 might offer a wide array of Canadians protection even once the above pro-rated exemption is factored into the equation, the situation would likely change radically for many Canadians acquiring U.S. property if the exemption is lowered to $1,000,000 as scheduled in 2013.
As such, Canadians wishing to purchase U.S. real estate should ensure they have a plan in place that anticipates the possible application of U.S. estate tax and seeks to mitigate its application insofar as possible prior to making any such purchase. By consulting an estate lawyer (or other qualified planner), a potential purchaser can determine whether they are close enough to the various thresholds to warrant the implementation of protective measures. For example, a married couple seeking to acquire U.S. real property may avoid the application of U.S. estate tax through the implementation of a family trust which is settled by one spouse and controlled by the other (along with an independent trustee). While this structure is not without complexity, as on the death of the trustee spouse the surviving spouse is required to pay reasonable rent to the trust for the continued use and enjoyment of the property, the avoidance of an asset based tax at 55% may be well worth the effort of establishing such a structure in many instances.
The above structure is just one of many potential options. And while every situation may not require the establishment of a structure to avoid the potential application of U.S. estate tax, Canadian residents should ensure they consider all of the potential tax risks when considering the acquisition of U.S. real property.
(i) William Hanley, Financial Post • Mar. 31, 2011, One in five Canadians eyeing U.S. housing market
Colin Green is an Associate at BrazeauSeller.LLP. Colin specializes in Tax & Estate Planning, but also practices in the areas of Corporate & Commercial Law and Family Business. To learn more about Colin, visit www.brazeauseller.com. Colin can be reached at firstname.lastname@example.org or 613-237-4000 ext. 227.