Are you considering purchasing or do you own a U.S. vacation property? Have you considered the potential U.S. estate tax that may be levied on your death? If you haven’t thought about U.S. estate taxes, you are not alone. Many Canadians looking to get into the foreign housing market do not consider the tax efficient ownership structure prior to making the purchase. Unfortunately, this could lead to unexpected taxes and liquidity problems for your estate.
Canadian residents owning a U.S. vacation property may be subject to both Canadian and U.S. income tax on the sale of the property, as well as U.S. estate tax on death. The U.S. government charges estate tax to a U.S. person based on the fair market value of the assets upon death. The current rate for the U.S estate tax starts at 18% and rises to 40% if the total value of the worldwide estate exceeds $1 million USD. As a Canadian resident, it is important to consider how the U.S. vacation property should be held to avoid U.S. estate tax in the future.
U.S. Estate Tax Exposure for Canadians
A resident of Canada may be subject to U.S. estate tax on U.S. property with a total value over $60,000 USD, if the value of the worldwide estate is over certain limits.
U.S. property subject to U.S. estate tax includes:
- Real property located in the U.S., such as a vacation property;
- Household goods and other property normally located in the U.S., including furniture, artwork, cars, and boats;
- U.S. issued stocks, mutual fund units, and money market units;
- U.S. pension plans; and
- Debt issued by U.S. persons or entities, or debt secured against U.S. property.
The U.S. provides a unified tax credit which reduces the overall U.S. estate tax payable on death. In 2021, the unified tax credit eliminates estate tax for U.S. persons whose worldwide estate value is not more than $11.7 million USD. The $11.7 million USD is the exemption amount and is adjusted for inflation annually.
However, even if the value of the U.S. vacation property is far below the exemption amount, a significant amount of U.S. estate tax could still apply to high net worth Canadian residents. For Canadian residents, the unified credit available is prorated based on the ratio of U.S. property compared to the total value of the individual’s worldwide estate.
For example, Sarah is a Canadian resident. If Sarah owned a U.S. vacation property worth $2 million USD and her Canadian estate is worth $18 million USD at the time of her death in 2021, she would be subject to U.S. estate tax of approximately $283,000 USD.
In addition, the Biden Administration has proposed to expand the U.S. estate tax by increasing the top tax rate to 45% and reducing the exemption amount to $3.5 million USD. If the proposed changes are passed into legislation, Canadians owning U.S. vacation property would have a much higher U.S. estate tax burden. Continuing with our previous example, Sarah would now be subject to U.S. estate tax as high as $649,000 USD; an increase of $366,000 USD.
The extent of the U.S. estate tax liability for Canadian residents owning a U.S. vacation property can be significant. It could also cause difficulties in estate liquidity since the vacation property is not actually sold and no cash is received to pay the U.S. estate taxes. This can be problematic for families that would like to keep the vacation property in the family for generations.
Strategies to Reduce the U.S. Estate Tax
Strategies to reduce the U.S. estate tax of a Canadian resident who is not a citizen or resident of the U.S. include selling the U.S. assets during the individual’s lifetime, setting up a Canadian holding corporation, or setting up a discretionary trust resident in Canada.
Selling the U.S. assets may not be a viable strategy if the property was purchased to be held long term. In addition, the sale of the property will trigger U.S. and Canadian capital gains tax which may have been deferred using an alternative tax structure.
Holding the U.S. assets such as a vacation property in a Canadian corporation is also not advised since it results in adverse tax consequences. For example, if Sarah was to transfer her U.S. vacation home to a wholly owned Canadian corporation, she will be assessed a taxable benefit personally every time she uses the vacation home for personal use.
Alternatively, if properly structured, a U.S. vacation property acquired and owned by a trust that is resident in Canada would allow for the avoidance of U.S. estate tax on the property, as the property is not owned by the Canadian resident individual at the time of death. CRA administrative position on this structure will also allow Sarah to access the vacation home for personal use without any tax consequences.
Additionally, the trust structure may provide other benefits such as creditor proofing. If the trust is structured as a Canadian discretionary trust, it can also provide flexibility in transferring the property to the next generation at the discretion of the trustees in the future.
Due to the significant impact and the expected increase of the U.S. estate tax for Canadian residents, it is important to properly structure the purchase of a vacation home to avoid U.S. estate taxes in the future.
For Canadians owning or acquiring a U.S. vacation property, holding the property through a family trust could be an effective strategy to reduce the U.S. estate tax burden. The strategy also allows for other benefits, such as creditor proofing, and flexibility for future intergenerational transfer. Careful consideration needs to be given on who is the settlor, trustee and beneficiaries of the trust to ensure negative tax implications are not triggered. In addition, once the structure is set up, certain rules need to be followed including who can contribute funds for capital expenditure and the upkeep of the property to ensure the structure is in compliance.
Grewal Guyatt LLP has extensive experience in dealing with cross-border purchases. We can help you understand your U.S. estate tax impact and assist you with strategies to reduce your U.S. estate tax liability. For more information and assistance with estate planning and ownership structure planning with respect to your vacation property and other U.S. assets such as stocks, please contact our tax team.
Mandeep Khosa, CPA, CA
Direct: (905) 780-3117
Elise Liu, CPA, CA, MMPA
Manager – Taxation
Direct: (905) 479-1700 ext. 4016