U.S. Real Estate: The Good News & The Bad News
One bright spot in the economic downturn is that, as U.S. housing prices have dropped and the Canadian dollar has grown stronger, Canadian residents have been snapping up bargains in American real estate, especially vacation homes.
If you are one of these fortunate homeowners, the income tax situation is straightforward if you don’t rent out the property. If there is no rental income associated with the property, you don’t have to file any tax-related paperwork in the U.S.
On the other hand, if you rent out the property, you will have to file a U.S. income tax return and it’s likely you will owe the U.S. Treasury some money. But, unless your rental property is located in California or New York, combined local, state and federal tax in the U.S. is generally lower than combined federal and provincial tax in Canada. Moreover, as a Canadian resident, any time you pay income tax related to commercial activity in a foreign country, you’ll get a tax credit in Canada. In the case of rental income, as long as the tax rate is lower in the U.S. than in Canada, you’ll get a dollar-for-dollar credit on your Canadian taxes.
When You Sell
Under the U.S. Foreign Investment in Real Property Tax Act (FIRPTA) of 1980, as a nonresident alien in the U.S., when you sell your real estate, in most circumstances you are required to pay U.S. withholding tax of 10 percent of the gross amount of the sale. This withholding amount is usually much higher than the tax that will eventually be due on the sale, which is why it is imperative that you apply for a “withholding certificate,” a type of withholding exemption, immediately upon signing a sales contract.
The U.S. Internal Revenue Service (IRS) will generally act upon these exemption requests within 90 days. If you fail to apply for a withholding certificate, it could be a year or more before the IRS correlates your actual taxes due against the 10 percent withholding you’ve paid and issues you a refund.
After You’re Gone
If the property is sold after the owner dies, the tax situation changes. In Canada, the property is deemed to have been sold just before the owner died, and the tax due is based only on the gain, if any.
Unfortunately for Canadians, in the U.S., estate tax is based on the actual sale price of the real estate, with no regard to the purchase price or gain. However, for tax years 2011 and 2012, the U.S. offers a $5 million estate tax exemption, which is made available to Canadians under the U.S.-Canada Tax Treaty. This means that if your worldwide assets are under $5 million when you die in 2011 or 2012, there is no U.S. estate tax due. (Note: this $5 million exemption drops to just $1 million in 2013.) For a married couple, the exemption amount for 2011 and 2012 is just under $10 million.
What Can You Do?
Given the complexity of the tax laws, it’s wise to consult with your CA before you purchase property in the U.S. There may be ways to structure the ownership of the property to mitigate tax liability via trusts, corporations, partnerships or joint ownerships with children. Of course, each of these arrangements has advantages and disadvantages.
If you already own property in the U.S., it’s not too late. There may be ways to change the ownership structure to avoid future tax issues.
If you own foreign real estate or are considering a foreign real estate purchase, contact us to discuss next steps.