Have a U.S. property? The tax man cometh
Many Canadian sunbelt homebuyers take the purchase plunge with little or no tax planning, says Edmonton tax lawyer Joe Yurkovich of Miller Thomson.
Buyers should talk to a Canadian lawyer about how to minimize tax exposure before buying. “You can get advice from a U.S. lawyer but a lot of it doesn’t apply to Canadians.”
One thing is certain for all Canadians who buy homes south of the border, Yurkovich says. He points out that at some time or another, you will all have to deal with the IRS (United States Internal Revenue Service).
Yurkovich says that estate tax is the first area of concern. If you die owning a home in the United States your estate could face a significant tax hit — especially under proposed amendments to estate tax law.
Estate tax — known in the U.S. as ‘death tax’— is levied on the estate of anyone owning assets valued at more than $60,000 in the U.S. American citizens are granted an exemption of $5 million and ‘aliens’ are given a prorated exemption, based on the percentage of their worldwide net worth that’s held in the U.S., explains Wendi Crowe, a fellow tax lawyer at Miller Thomson in Edmonton.
For Canadians, this means that if you have worldwide assets of $2 million and own a home in Phoenix valued at $200,000, you hold 10 per cent of your net worth in the U.S. and are entitled to 10 per cent of the exemption allowed to US citizens. This works out to $500,000 under the current law. So long as the value of your U.S. home has not increased significantly and your net worth has not decreased, no estate tax would be owing upon your death. (If you own U.S. securities, these are also counted and a large portfolio could change the result.)
But the level of exemption is about to change.
Yurkovich says the current proposal before legislators would reduce the exemption for American citizens from $5 million to $1 million in worldwide assets as of 2013. In the case of a Canadian with total assets of $2 million and a U.S. home worth $200,000, the resulting 10-per-cent exemption on a $1-million ceiling would work out to $100,000, leaving $100,000 of real estate value exposed to state and federal estate tax.
The federal estate tax rate is graduated between 24 and 35 per cent and Arizona has imposed no estate tax since 2005. So your estate could be liable for $24,000 or more in U.S. estate tax. And if your property appreciated in value to $300,000 before your death, your estate could owe $48,000 or more to the IRS. If your heirs plan to sell the home, they can pay taxes from the proceeds of the sale. But if they want to keep the property in the family, they will have to find some other way to pay the taxes.
Crowe adds that such calculations assume that the current proposal is passed into law without change, and that’s far from certain.
“The proposal is to move to a $1-million exemption but you really never know. The last time they changed it, the expectation was an exemption of $3.5 million. But they made it $5 million. At this point, it’s just speculation,” Crowe says. She sometimes recommends buying the second home through a trust or partnership that lives on after the death of the individual and prevents the property becoming part of the estate.
She adds that giving the property to your children before your death doesn’t work because that triggers a U.S. gift tax similar to the estate tax. But she says some clients have deferred the estate tax problem for a generation by having children make the initial property purchase and allowing parents ‘generous use’ of the home.
Montreal tax lawyer David Altro says he regularly creates cross-border irrevocable trusts, or C-BITs, as the best solution to estate taxes.
“When Canadians die with U.S. real estate (it’s usually because) they want to leave it to their kids,” he says. So they need a trust or other means of ensuring that their children aren’t lumbered with a huge tax bill.
The simplest solution to estate tax is to sell your U.S. property before you die, but this means dealing with capital gains taxation in the U.S. Selling U.S. real estate — and possibly paying capital gains — is also a growing concern for Canadians because many bought in recent months on the expectation that depressed US housing prices would rebound within some number of years and generate a profit.
“A lot of people are waiting for the bounce,” Altro says.
Altro is skeptical about the chances of any large gain in U.S. real estate values in the short to medium term. But he concedes that sunbelt real estate may eventually rise again. Still, even if there is no capital gain, capital gains taxation is likely to be an issue.
The sale of a U.S. property requires filing a U.S. tax return and a payment of tax on any capital gain (after deductions for upgrades to the property). And anyone who buys a US property from an ‘alien’ must, by law, withhold 10 per cent of the purchase price and remit it to the government to cover capital gains by the seller.
Yurkovich observes that anyone selling in today’s market is unlikely to see a significant capital gain but will still face having 10 per cent of the sale price of their property withheld by the title company that functions as a middleman between buyer and seller in U.S. residential real estate transactions. The alien seller can claim this money back on a U.S. income tax form and wait up to a year for a tax refund or he or she can make an application in advance of the sale to have the withholding amount reduced.
Regardless of how much is eventually paid to the U.S. tax man, most Canadians will be taxable in Canada on their worldwide income, including proceeds of that US second home sale. But Crowe says they usually can claim the U.S. payment as a deduction against the tax owing in Canada, thus avoiding double taxation.
Some Canadian homebuyers look at these purchases as investments and often consider renting Phoenix property on a part-time basis, or even buying a second property as a full-time rental. But aliens are required by law to retain an agency to handle rentals and many Canadian buyers may be less than eager to put themselves in a situation that requires filing income tax in two countries every year.