Given the high value of the Canadian dollar and the low value of US real estate during the past years, some Canadians have been buying US real estate properties. There are a number of things to consider before taking this step:
If you rent out the property for over 14 days in the year, you will be required to pay US income tax on the rent. The US charges a flat 30 per cent tax on your gross rental income. This can only be reduced by applying for a US tax number, and then filing a US tax return, calculating tax on the basis of your net rental income (i.e., after deducting costs like interest, repairs, condo fees, property taxes, etc). This calculation almost always results in a refund of taxes. But if you don’t file this return on time, the IRS (US tax department) can deny your right to file it at all, and you’re left with the 30 per cent tax on gross rentals. The same income must also be reported on your Canadian return, but you can usually get a credit in Canada for any US tax paid on your rental income (as per your US tax return filed). The US calculations for net rental income are different than in Canada, so you’ll need to get US advice when preparing this return.
- You’ll need to be careful which state you buy in as well. Certain states such as Florida don’t have state personal income tax, but other states popular with Canadians such as Arizona and California will require you to file a state return as well as the federal return. Some states have higher property taxes for non-residents.
- You should investigate the property carefully. Many properties are being sold now at a very low price, but with dubious legal titles, so be sure that you are not buying a lawsuit. If it is a condo property, be sure that the condo itself is properly funded so that it can finance future necessary repairs, and check to see if there are major assessments coming. Also, buyers should be aware that property taxes in some parts of the US can be very high.
- When you sell the property, you will have some of the gross sale price (usually 10 per cent) withheld automatically and sent to the IRS. This tax prepayment is calculated based on your sale price, not on your actual gain, so it is usually too high. You can only recover the excess by filing a US return to report the sale. Again, you’ll need US advice to be sure that you’ve calculated the gain correctly. You can only claim a foreign tax credit in Canada for US tax payments once you have filed a proper US return.
- When you die, your US real estate assets are subject to US estate tax if your worldwide assets are over a minimum gross value threshold. Many Canadians have been unpleasantly surprised to discover that simply owning US real estate can mean that the estate of a Canadian resident must pay US estate taxes when that person dies. If you haven’t bought any US property yet and you are concerned that US estate tax could affect your estate, you may want to consider holding off your purchase until you have clarified the tax rates and thresholds that will apply to you.
- There are various complex strategies which have been used over the years to reduce US estate taxes, but this decision should only be made after getting Canadian and US tax advice. For example, some Canadians have used a special type of US mortgage loan (“non-recourse financing”) to reduce their US estate tax. Other Canadians have held the property jointly, so that the deceased’s estate is only taxed on half the value, or they defer the tax until the second spouse dies by putting the US property in a special type of US trust. Since 2005, when the Canadian tax department (CRA) changed the Canadian tax rules, it no longer is advisable for a Canadian to hold a US vacation property inside a Canadian holding company. Some Canadians choose to hold their US property in a special type of Canadian trust, which avoids any US estate tax on one’s death, (but creates other Canadian tax problems if one’s spouse dies first).
- If you have non-personal use assets outside Canada which cost you over CDN$100,000 you must report them to the CRA every year, along with any income you earned on them during the year. So if you already had assets with a cost of CDN$20,000 anywhere outside Canada, and you pay at least CDN$80,000 for a US rental or investment property, you’ll now have to file this report. You don’t have to include a real estate property which is purely for personal use.
Investing in US real estate has many attractions right now, given the state of the US market and the strength of Canadian buyers. But any buyer should first be aware of the Canadian and US income tax issues involved in holding the property, and in selling it later, as well as the US estate tax issues involved if the buyer should die before selling the property. These issues are extremely complex, but they should be thought through before making any investment in US real estate.
David Chong Yen, CFP, CA of DCY Professional Corporation Chartered Accountants is a tax specialist and has been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.org. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas and is not intended to replace professional advice.