In Canada, a common way of owning property is in joint tenancy. Frequently, a husband and wife will own real estate, such as a home, in joint tenancy. In the right circumstances, such ownership can be an excellent estate planning strategy: on the death of the first spouse, the property transfers automatically to the second spouse without triggering any income tax, property transfer tax or probate fees. However, if the property is located in the United States, ownership in joint tenancy can result in significantly higher taxes becoming payable.
As noted above, in Canada, a transfer to a joint tenant that is a spouse on death will typically not cause any income tax to become payable. Such tax is essentially deferred until the death of the second spouse. If the transfer is made to a joint tenant that is not a spouse, income tax may become payable by the deceased as a result of death. In such circumstances, the Canada Revenue Agency values the interest of a deceased joint tenant to be equal to 50% of the value of the whole of the property.
In the United States, on the other hand, a joint tenant’s interest in property is presumed to be equal to 100% of the value of the whole of the property. Thus, on the death of the first joint tenant spouse, that deceased spouse will be presumed to have disposed of 100% of the property and taxes will be levied on that basis. The exception to the application of this presumption is where the surviving spouse can prove that he or she made an independent contribution to the purchase of the property. Providing such proof could very well be difficult, or even impossible, for spouses who have combined assets. More often than not, the result will be that taxes will be payable in respect of 100% of the value of the property on the death of the first spouse.
Further, in the United States, on the death of the second spouse, the second spouse is also presumed to have owned 100% of the value of the property. Thus, the full value of the property will be taxed by the United States on the death of the first spouse and then again on the death of the second spouse.
The bad news does not end there. Although foreign tax credits are available to offset situations where both Canadian and United States taxes are payable in respect of the same property, on the death of the first joint tenant spouse there typically is no Canadian tax payable. Accordingly, there will be no foreign tax credit available on the death of the first spouse unless an election is made for Canadian purposes to cause Canadian income tax to become payable in respect of the deceased’s interest in the property. Even if such an election is made, there will be a mismatch of the percentage interest disposed of (i.e. 100% for US purposes vs. 50% for Canadian purposes).
One simple solution to the above pitfalls is to own the property as tenants in common. When the property is held in this manner, for both Canadian and United States tax purposes, each tenant in common is considered to have disposed of only their 50% interest on death. Tax will therefore be payable based on the value of that 50% interest. Also, the foreign tax credit will be available on the death of the first spouse (if an election is made to cause Canadian income tax to become payable) in respect of that 50% interest.
Other strategies are also available for structuring ownership in United States property, which could be advantageous depending on individual circumstances. It is important to seek the appropriate legal and tax advice before making the purchase.
For more information on related matters, contact Melodie Lind who is part of our Tax Law Group at: [email protected] or (250) 869-1210
