In recent years, Canadians have been bullish on the real estate market south of the border. Whether U.S. property is purchased for rental or strictly personal use, investors should carefully consider how the property is purchased and understand their ongoing tax obligations. This article will discuss some of the key issues that Canadian investors should be aware of when purchasing property in the U.S.
U.S. Estate Tax
Unlike the Canadian tax system, the U.S. tax system levies an estate tax on assets owned upon death. For U.S. noncitizens, this applies only to U.S. property. By default, the estate tax rate is assessed on the market value of U.S. property owned upon death in excess of USD $60,000 with the tax rate that can reach as high as 40%. This tax can be mitigated as follows:
Applying a prorated credit per the Canada-U.S. Tax Treaty: U.S. citizens are subject to estate tax on their worldwide assets, but are eligible to apply a credit, which will fully offset their estate tax when the value of their total (worldwide) estate is less than USD $13.61M (as of 2024). Per the Treaty, noncitizens are eligible for this same credit but prorated based on the ratio of their U.S. assets to their total assets. In essence, investors whose total estate is less than this threshold will not be subject to U.S. estate tax.
Purchasing U.S. property through an appropriate entity: This will shield the asset from estate tax (e.g., Canadian corporation or trust). Each entity has their own tax features which will help determine which structure is optimal for each investor’s situation.
Ongoing Reporting – Tax Filing Obligations
If rental income is earned by a Canadian individual or a Canadian corporation, it is taxed by default on a “gross” basis at a rate of 30%. However, an election can be made to tax the rental income on a “net” basis and at graduated tax rates (or, in the case of a Canadian corporation, at a flat rate of 21%). The election will also allow for the deduction of rental expenses, including depreciation, to offset rental revenue, resulting in lower taxes.
A U.S. tax return is required every year to report U.S. rental activity and any capital gain on the sale of the property. This rental income or capital gain is also reported on the Canadian tax return, but to mitigate double taxation, any U.S. tax paid is generally eligible for a foreign tax credit to offset Canadian tax owing.
FIRPTA
The Foreign Investment in Real Property Tax Act (“FIRPTA”) is a U.S. tax withholding regime that applies to dispositions of U.S. property by noncitizens and non-residents. When applicable, the buyer must withhold an amount of the gross proceeds (generally 15%) and remit it to the IRS. The Canadian seller applies this withholding as a credit to offset their U.S. tax payable when filing their tax return to report the capital gain. Because this withholding is typically on a gross basis, this results in an overestimation of the ultimate U.S. tax owing, which usually results in a refund. This initial overpayment of tax can be avoided as follows:
Withholding certificate: By applying for a withholding certificate at the time of sale, the IRS will permit the buyer to withhold a lower amount that approximates the ultimate tax due on the capital gain.
Purchasing U.S. property through a U.S. corporation: FIRPTA will not apply when a U.S. citizen or resident corporation owns the property being disposed of. Therefore, incorporating and purchasing U.S. property through a U.S. corporation (often owned by a Canadian holding company) will avoid this regime.
Limited Liability Company
A Limited liability company (LLC) is often touted by U.S.-based lawyers and accountants as an entity through which to purchase U.S. real estate. An LLC offers similar liability protection to a corporation without the additional tax filing obligations. The activity of an LLC flows through directly to its owner, so losses aren’t “trapped” as they would be if the property were owned by a corporation.
It is important to note that an LLC can have significant adverse cross-border tax consequences when it is owned by a Canadian individual. Any structure involving an LLC must be set up carefully under the guidance of a cross-border tax advisor.
GG Observations
Because there is no one-size-fits-all approach, it is imperative that your advisor understands your situation and objectives to help determine the optimal structure for your U.S. real estate purchase. Grewal Guyatt LLP has cross-border professionals what will provide an individualized cross border planning that fits your needs, allowing you to take advantage of investments south of the border.
