With the strong Canadian dollar and attractively low real estate prices in the US, more and more Canadians are purchasing real estate in the US. Some of the considerations prior to doing so should be the tax implications and whether or not ownership should be through a Canadian trust.
Under the Canadian system of taxation, Canadians are taxed in Canada on their “world wide” assets, wherever they are situated. Under the US system of taxation and the Canada-US Tax Treaty, Canadians can be taxed in the US on their US assets. The result is that, once a Canadian owns US property, he or she is potentially subject to tax in both countries. Fortunately, the Canadian Income Tax Act and the Canada-US Tax Treaty has a system of foreign tax credits and exemptions that in many cases will ensure that a Canadian only pays tax in an amount equal to the tax owing in the higher-rate country.
One area of potential tax concern, however, is the US estate tax system. When a Canadian dies owning US property, he or she is subject to US estate tax on US assets. Under the Canada-US Tax Treaty, a Canadian is only entitled to a pro-rated portion of the US estate tax exemption amount. Because US estate tax is calculated on the full value of the US assets (and not on the gain that has accrued since the property was acquired, as is the case in Canada), the potential estate tax bill can be quite high.
The US estate tax problem for Canadians is worsened by the current legislation in the US that will see the US estate tax exemption amount drop down from $5 million to $1 million, and the maximum US estate tax rate increase from 35% to 55%. This is scheduled to occur beginning in 2013, unless new laws are enacted.
Canadians are therefore well advised to seek the assistance of a qualified professional to calculate the potential US estate tax exposure before purchasing real estate in the US. If the potential tax is high enough, it is a good idea to consider owning the US real estate through a Canadian trust.
A properly structured and managed Canadian trust can avoid US estate tax while still being an effective vehicle from a Canadian tax standpoint. Because the trust can continue to exist following the death of an individual, death does not trigger the application of US estate tax. Likewise, Canadian capital gains tax will not be triggered on the death of an individual. There will also be no loss of the foreign tax credits available in respect of the capital gains tax payable (if any) when the US property is ultimately sold. As an additional benefit, the US property will not be subject to the probate process on the death of an individual. This is an excellent tool in the right circumstances.
One of the hurdles in successfully using a Canadian trust to own US real estate is that the trust must be established before the US real estate is purchased, and before an offer is even made on a particular property. Planning well in advance of any potential purchase is therefore essential.
For more information on related matters, contact Melodie Lind who is part of our Tax Law Group at: [email protected] or (250) 869-1210
