Given the attractive U.S. real estate market, the strong Canadian dollar and low interest rates, more and more Canadians are purchasing U.S. vacation properties.
Canadians should be aware, however, of the potential exposure to U.S. Estate Tax on death. Simply stated, a Canadian owning assets in the U.S. on death (such as real estate) is liable to U.S. Estate Tax on the value of all U.S. “situs” assets and benefits only from a limited tax credit, proportionate to the value of the U.S. assets over the worldwide estate. Hence, if the U.S. property represents only a small percentage of a large worldwide estate (over $3,500,000 U.S.), the tax credit will be minimal. The U.S. Estate Tax rates range is from 18% to 45% and may create a substantial tax bill on death.
It is possible, with proper planning, to eliminate exposure to U.S. Estate Tax and it is usually preferable to implement such planning prior to the acquisition of the vacation property.
One technique involves the use of a Canadian trust. Under this plan, the Canadian would settle a Canadian discretionary trust and transfer to the trust the funds necessary for the purchase of the U.S. property. The Canadian contributor, however, may not be a beneficiary nor a trustee of the trust. Typically, the beneficiaries would include the spouse of the contributor and his or her children. If properly implemented, this structure eliminates U.S. Estate Tax exposure both on the death of the Canadian contributor and on the death of his or her spouse. It also permits the gain on a sale of the U.S. property to be taxed in the U.S. at the favourable federal long-term capital gains rate applicable for individuals (currently 15%). From a Canadian point of view, it minimizes Canadian taxation on death as the property is owned by the trust and not by the Canadian contributor and would not be subject to a deemed disposition at fair market value on the death of the Canadian contributor or his or her spouse. The trust would, however, be subject to the deemed disposition of all of its assets at fair market value 21 years after its creation, unless steps are taken to avoid this result.
Another alternative may be to minimize U.S. Estate Tax exposure by purchasing the U.S. property through a Canadian limited partnership. This planning is more complicated and raises various issues to consider (such as the need to have the partnership treated as a corporation in the U.S. and hence, subjecting any gain on a sale of the property to the higher corporate tax rate).
Finally, another option would be to use a Canadian corporation to purchase the property. The Canada Revenue Agency considers that if the property is made available to the shareholder, a taxable benefit will arise, that may not be limited to fair market value rent and might be based on the cost or value of the property. The benefit would, however, be reduced if the funds to purchase the property are provided interest-free by the shareholder to the corporation. The property being owned by a corporation, any gain on a disposition of the property would be taxed in the U.S. at the corporate rate. At the Canadian level, the shareholder (or the shareholder’s spouse, as the case may be) will be deemed to have disposed of the shares of the corporation at fair market value on death.
Purchasing a U.S. vacation property is an important decision that should not be taken lightly. Canadians contemplating such purchase should consult their tax advisors in order to properly implement a structure meeting their particular needs and situation. We can help you with this.