Canadian snowbirds flock to Florida to assess the damages caused to their vacation homes following Hurricane Irma. For those who find their homes destroyed by the powerful storm, they may wish to buy new properties altogether. There are various ways to buy a vacation property in the U.S. and things to keep in mind.
Canadian residents who are Non-Resident Aliens of the U.S. (individuals who are not U.S. citizens or residents, whose domicile is not in the U.S. and are not U.S. green card holders) (“CNRAs”) may be subject to U.S. estate tax on U.S.-situs property with a total value over $60,000US if the value of their worldwide estate is over certain limits. Within the definition of U.S.-situs property falls U.S. real estate, including condominiums, co-operatives, and time shares.
There are various methods of acquiring U.S. vacation property. Prior to 2005, it was a common strategy to hold a U.S. vacation property in a “single-use personal holding corporation” to avoid U.S. estate taxes and probate. The Canada Revenue Agency had a lenient administrative policy with respect to the shareholder benefit rules that made this method of holding U.S. vacation property popular for Canadians. As of January 1, 2005, the rules changed, making this strategy no longer optimal.
Common methods today include:
Sole Ownership: Personally owning U.S. vacation property may expose you to U.S. estate tax on death, unless the property passes to your U.S. citizen spouse, in which case a marital deduction exempts the CNRA from U.S. estate tax. Under the Canada/U.S. Tax Treaty, if a CNRA leaves U.S. property to a CNRA spouse on death, a marital credit is available, or if a CNRA provides for a Qualifying Domestic Trust (“QDOT”) in his/her Will, the property may be “rolled over” to the QDOT to defer tax until the spouse dies or disposes of the property. Under Canadian income tax law, there will be a deferral of capital gains tax until the spouse dies or disposes of the property. There are also other credits that may be available to offset the U.S. estate tax which is paid.
Joint Tenancy with Right of Survivorship: In order to be a true joint tenancy, both spouses have to jointly contribute to the purchase price of the property. Otherwise, it could be deemed a gift from the contributing spouse to the non-contributing spouse and U.S. gift tax may apply. If U.S.-situs property is owned as true joint tenants between CNRA spouses, the property will not be subject to the Will on the death of the first spouse, but will pass to the surviving spouse/owner by operation of law. Under Canadian income tax law, there is a deferral of capital gains tax on the property until the second spouse dies or disposes of the property. However, the full value of the property will be subject to U.S. estate tax at the time of death of the first spouse and then again at the time of death of the second spouse/owner.
Non-Recourse Mortgage: A non-recourse mortgage is an obligation that is enforceable only against the property pledged as security, and the owner of the property cannot be forced to pay the mortgage personally. The value of a non-recourse mortgage may be deducted directly from the value of the U.S.-situs property to, in effect, minimize U.S. estate tax which may be payable. U.S. estate tax is only paid on the equity in the property. The mortgage must have commercial terms, so the mortgagor spouse must pay interest to the mortgagee spouse and the mortgagee spouse must report the interest as income on his/her income tax return. This strategy does not protect future growth; if the property increases in value, the mortgage does not increase.
Canadian Trust: This is the most common method for CNRAs to purchase U.S. property, primarily because the property will not be form part of the estate of the CNRA, or any of the beneficiaries of the trust, for U.S. estate tax purposes. As well, probating the CNRA’s Will is unnecessary to deal with the property, and the trust structure offers creditor protection.
The rules for setting up these trusts are quite stringent so it is best to retain a solicitor for advice and assistance before engaging in this type of planning. Some of the requirements include the following: (a) the trust must be settled by one CNRA spouse; (b) the trust must acquire the property; (c) the other CNRA spouse should be the beneficiary and trustee; and (d) the settlor spouse cannot be a beneficiary or trustee.
The terms of the trust usually give the beneficiary spouse the right to use the property for his/her lifetime, and on his/her death, the alternate beneficiaries are the children. The settlor spouse may use the property at the “sufferance” of the beneficiary spouse while the beneficiary spouse is alive. However, if the beneficiary spouse predeceases the settlor spouse, the settlor spouse must pay fair market value rent to the trust if he/she wants to continue to use the property.
It is important to keep track of time as, under Canadian income tax law, there will be a deemed disposition of the property in the trust every 21 years and any gain on the property will be taxable at that time.
There are advantages and disadvantages of each method outlined above so Canadian snowbirds should speak to a solicitor about their particular circumstances before buying U.S. property.