Canadians Acquiring US Residential Real Property: Cross-Border Considerations William Fowlis and Edward C. Northwood William Fowlis. Miller Thomson llp , Calgary. bC omm (1978), llb (1986) University of Alberta; CA (1980); Tep . Chair, Calgary branch, Society of Trust and estate practitioners. presenter on tax topics to various conferences; author of articles for many publications; frequent lecturer in income tax courses for the Institute of Chartered Accountants of Alberta. Edward C. Northwood. The Ruchelman law Firm, Toronto. bA , brown University; MA , SUny (Albany); jd , SUny (buffalo). Frequent speaker and author on cross-border tax and estate planning and trust and estate administration. Member, Society of Trust and estate practitioners; member, Toronto estate planning Council. Fellow, American College of Trust and estate Counsel; academician, International Academy of estate and Trust law. Abstract The authors discuss US and Canadian income tax, estate tax, and gift tax ramifications relating to ownership of US real property by Canadians. They also discuss the considerations respecting, and planning issues relevant to, four different types of structures for the ownership of US real property by Canadian residents— ownership by an individual, ownership by a Canadian corporation, ownership by a Canadian-resident trust, and ownership by a Canadian partnership. Keywords Real property; US -Canada; estate taxes; estate planning; cross-border; individual income taxes. Introduction An increasingly common investment for Canadians is residential real estate, primarily vacation properties, in the United States. Ownership of US real estate by Canadians creates numerous tax ramifjcations. In the United States, two re- gimes are of primary concern—the income tax regime and the gift and estate tax regime. In Canada, the income tax regime is applicable. Coordination of the two different taxing jurisdictions is vital; the taxpayer and the taxable event must be synchronized in order to minimize the overall tax consequences that may result from such investments. 40:1
40:2 WILLIAM FOWLIS AND EDWARD C. NORTHWOOD While the structures that are often considered tend to focus on US issues, it is essential for Canadians to be aware of the Canadian tax issues that arise from the purchase, rental, sale, or deemed disposition of US residential real estate. An approach that integrates the US and Canadian rules in an effective way is important to achieve. Such an approach may result in balancing the advantages and disadvantages of a particular structure; no one structure or approach will work best in all circumstances. In this paper, we discuss personal-use and rental residential real estate. Com- mercial real estate issues are beyond the scope of the paper. The Canadian income tax rules that can have an impact on the ownership of US real estate include 1) the deemed disposition that occurs on the death of a taxpayer owning US real estate; 1 2) the income attribution rules that apply where a taxpayer other than the tax- payer who actually owns and disposes of a property is required to report the disposition for Canadian income tax purposes; 2 3) the Canadian benefjt inclusion (imputed income) rules; 3 and 4) the deemed disposition by a Canadian-resident trust of all of its capital property on the 21st anniversary date of the creation of the trust. 4 The US income tax rules relevant to Canadian ownership of US real property include 1) determination of rental income net of deductions for non-resident owners; 5 2) taxation of gain under the 1980 Foreign Investment in Real property Tax Act ( FIRpTA ); 6 3) withholding taxes with respect to both income categories; 7 and 4) US benefjt inclusion (imputed income) rules. 8 In addition to the coordination of the domestic tax laws of the two jurisdic- tions, ownership decisions and management practices should take into account the utilization of the Canada- US tax treaty, 9 the coordination of foreign tax credits under Canadian law, 10 the differences in the two jurisdictions’ domestic death tax laws, and variable foreign exchange rates. Overview of the US Transfer Tax System The US gift and estate tax is an excise tax on gratuitous transfers (property of any kind that is transferred directly or indirectly from one person to, or for the benefjt of, another for less than full and adequate consideration) during life or on death. 11 Transfer tax is based on the value of the property transferred. Taxable gifts are those in excess of permitted exclusions, such as the annual exclusion for gifts to any person ( US $13,000 per year beginning in 2009), direct payment of tuition or medical expenses, gifts to US -citizen spouses, and gifts to qualifjed
CANADIANS ACQUIRING US RESIDENTIAL REAL PROPERTY 40:3 charities. 12 There is an enhanced annual exclusion for gifts to a non- US -citizen spouse ( US $133,000 for 2009). 13 The US estate tax base (the gross estate) includes the value of all personally owned assets as well as the assets that make up certain trusts (trusts to which the decedent contributed where the decedent retains certain interests, 14 and trusts created by others for the decedent over which the decedent is considered to possess a general power of appointment). 15 Assets that make up the gross estate include the death benefjt of insurance on the decedent’s life unless the policy is owned in all respects by others. The gross estate is reduced by permitted deduc- tions, yielding the taxable estate. Gift and estate taxes are unifjed by adding cumulative lifetime taxable gifts to the taxable estate. The sum in excess of the exemption ( US $3.5 million in 2009 for US citizens and domiciliaries) is subject to estate tax at the rate of 45 percent. 16 permitted deductions include gifts to a US -citizen spouse (including a spousal trust), 17 gifts to qualifjed charities, 18 liabilities of the decedent that had accrued as of the date of death (including income taxes), 19 and funeral and estate admin- istration expenses. 20 estate tax credits are also available; the primary estate tax credit is the unifjed credit, which is the amount of tax that would have been im- posed on a taxable estate aggregating US $3.5 million. There are also credits for foreign death taxes, for estate taxes paid with respect to relatively recent inherit- ances, and for gift taxes paid during life. 21 As in Canada, estate taxes may be deferred until the death of the second to die of a married couple. If the surviving spouse is not a US citizen, then the de- ferral is obtained only through the use of a qualifjed domestic trust ( qdOT ), the primary features of which are that the surviving spouse is the only benefjciary during his or her lifetime, the surviving spouse receives all of the income of the trust, there is a US trustee, and the trust is subject to a US jurisdiction. 22 Canadians who are not US citizens will be subject to the US gift and estate tax regimes only with respect to their US -situs assets. US -situs assets for US gift tax purposes include those that are owned individually (or through a lookthrough entity, such as partnerships or certain trusts) and interests in real property and tangible personal property (generally, the contents of real property, but including boats and vehicles) located in the United States. 23 US -situs assets for US estate tax purposes include the categories above, as well as shares of US stocks and debt of US persons or companies. 24 US stocks are those of companies that are organ- ized under the laws of a state; it does not matter where the shares are traded or located. Most publicly traded US bonds are excluded from the debt category. Unlike a US citizen or resident, however, a Canadian who transfers an asset that is subject to US gift tax (such as an interest in US real property) has no exemp- tion by which to avoid the actual payment of gift tax. Only the annual exclusions identifjed above are available to reduce gift tax liability. Considerable relief with respect to US estate tax is accorded to Canadians under the treaty. 25 First, the Canadian estate is entitled to a prorated unifjed credit against estate taxes (in effect, a share of the US $3.5 million exemption.) The
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