As the thermometer continues to hover around the zero degree mark, many of us who live north of the 49th parallel begin to think about heading south to take up residence in one of the many sunnier climes the United States has to offer. As the Canadian dollar continues to hover around par and the value of U.S. real estate in those sunnier climes continues to remain soft, those of us who live south of the border allow visions of vacation property ownership to dance in our heads. Unfortunately, as written about in earlier blogs, ownership of U.S. real property by a Canadian citizen and resident can result in the payment of U.S. estate taxes.
If the value of the U.S. real property does not exceed U.S. 60,000 at the time of death of a Canadian owner, then no U.S. estate taxes are payable. This is because Canadians are entitled to a credit under the Internal Revenue Code of U.S. $17,000 which covers property of this value. If the value of the U.S. real property exceeds this amount on the Canadian owner’s death, there are planning options that can be implemented to avoid, reduce or defer the payment of U.S. estate taxes. As is the case with most planning though, it must be done prior to the acquisition of the U.S. real property.
The planning available generally takes the form of either reducing the value of U.S. real property that the Canadian owner owns on his or death or ensuring that the Canadian owner does not have the kind of interest in U.S. real property that is caught by the U.S. estate tax net.
One option is to acquire the U.S. vacation property by a non-recourse mortgage. The goal here is to reduce the Canadian owner’s equity. A non-recourse mortgage is one that doesn’t expose the borrower to personal liability. The only recourse the lender has is to the property itself. It is this feature that makes this financing difficult to obtain from a bank. Typically a bank will limit this debt to 50% to 60% loan-to-value ratios. To the extent the owner’s equity increases (e.g. the property increases in value), the exposure to U.S. estate taxes will increase.
Another option is to have various family members buy an interest in the U.S. vacation property. This allows each of them to access the US $17,000 credit available to Canadians. If the interest each family member has on their death does not have a value that exceeds U.S. $60,000, then no U.S. estate tax will be payable. For this to work, each family member must contribute their proportionate share of the purchase price.
Prior to 1995 it was quite common to own a U.S. vacation property through what was known as a Canadian “single purpose corporation”. In 1995 the Canada Revenue Agency changed its administrative policies regarding shareholder benefits attributable to shareholders who have the use of corporate owned real property. Since then, this technique is no longer widely recommended.
Another option is to have a Canadian irrevocable discretionary family trust acquire the U.S. vacation property. If properly structured, this form of ownership should avoid the value of the U.S. vacation property forming part of the estate of the settlor and the trustees. Whether any of the beneficiaries is subject to U.S. estate taxes will depend upon the type of trust interest the beneficiary has.
As with any form of foreign property ownership, there will likely be other tax considerations that ought to be considered. Without considering all potential tax ramifications, a Canadian may be subject to some unexpected surprises. It is beyond the scope of this blog (or frankly any blog) to provide sufficient information. Prudence would dictate that appropriate advice is sought prior to the acquisition of property in any foreign jurisdiction.
Happy New Year!