Should a Canadian Hold U.S. Real Estate in a Corporation, LLC, LP or LLP?

When a Canadian citizen wants to acquire investment real estate in the United States, one of the first questions the investor must answer is “should the real estate be held in a U.S. corporation, limited liability company, limited partnership or limited liability partnership?”  For the reasons discussed below, I recommend that Canadians acquire  real estate in the United States only in U.S. limited partnerships.

Canadian Tax Issues

I have been told by many Canadians that because of Canadian tax law, Canadians should not own real estate in the U.S. in a U.S. limited liability company, but should use the limited partnership  (LP) or limited liability partnership (LLP).  Apparently, Canadians who own U.S. real estate in a U.S. corporation may incur greater Canadian tax than would occur if the same property were owned in a U.S. partnership.  An article in KPMG Canada Global Tax Advisor called “CRA Says Conversion of Delaware LLC Results in a Taxable Disposition” states:

A Delaware LLC is classified as a corporation for Canadian income tax purposes.

In Technical Interpretation Bulletin 1999-0010305 (Feb. 21, 2000) the Director Reorganizations and International Tax Division Income Tax Rulings Directorate Policy and Legislation Branch  found that the Canada Revenue Agency (CRA) applied the same general principles to income of and distributions by a limited liability company organized under the laws of Delaware as to which a Canadian tax resident was a member.  In this Bulletin, the Delaware LLC was taxed as a partnership under U.S. income tax law, but “the LLC is treated as a corporation for Canadian tax purposes.”  See also “CRA Views on Foreign Entity Classification.”

For a contrary view that says a U.S. LLC taxed as a partnership will not be considered a corporation for Canadian tax law purposes, see an article by Moodys, LLP called “Basic Income Tax Considerations When Establishing a U.S. Presence.”  Note:  A U.S. LLC may not be taxed as a partnership if it is a single member LLC.   This article explains that Canadians  should  avoid corporations because the owners of corporations are subject to double tax (first at the entity level and then at the owner level when net proceeds are distributed to the owners).

In talking to Canadians who have asked me to form an LLP or LP for their Arizona real property, I have raised the fact that it is possible for a U.S. multi-member LLC to be taxed as a partnership under U.S. tax law.  Some of the Canadian have told me that under Canadian tax law that fact does not matter because Canada still considers a U.S. LLC to be a corporation for Canadian tax law purposes.

An article published in the Canadian Petroleum Tax Journal in 1997 called “Update on Cross-Border Tax Issues” by Stan R. Ebel and Edward C. Ostterberg, Jr., sheds light on this subject.  The article makes the following statements:

An LLC may be treated as a corporation for Canadian income tax purposes notwithstanding the U.S income tax treatment of the LLC . For example, Revenue Canada has indicated that LLCs formed under Delaware, Texas, Wyoming, Indiana, Michigan and Florida law will be treated as corporations. . . .

One of the consequences of the characterization of an LLC as a corporation is that an LLC may qualify as a “foreign affiliate” of a Canadian resident for the purposes of the Act and Income Tax Regulations. . . .

Tax imposed by the U.S. on members of an LLC in respect of the LLC ’s income will not be treated as tax paid by the LLC for the purposes of the Act and the Regulations.  This interpretation may give rise to adverse Canadian income tax consequences where the LLC earns “foreign accrual property income” or “taxable surplus” income due to the mismatching of income and tax.

Since an LLC which is treated as a partnership for U.S. income tax purposes is not itself subject to tax in the U.S. it will not be treated by Revenue Canada as a U.S. resident for the purposes of applying the provisions of the Treaty.  More particularly, Revenue Canada takes the view that in order for a corporation to be considered a resident of the U.S. for the purposes of the Treaty, it must be liable to tax in the U.S. on its worldwide income in the same manner as are corporations incorporated under U.S. law.  On that basis, Revenue Canada takes the position that an LLC will not be able to claim the benefits of the Treaty. . . .

Based on the foregoing, considerable caution must be exercised in structuring cross-border arrangements involving LLCs.

If you are a Canadian interested in acquiring U.S. real estate, consult with your Canadian tax law adviser to determine if you should use an LLC (this is what most people form in Arizona for real estate holdings) or an LLP or LP.  This post is not intended to be advice on Canadian tax law.

The concepts discussed in the preceding article are explained and expanded on in “Canadians Investing in Limited Liability Companies.”

United States Entity Formation Issues

The four most commonly used entity types in the United States in the order of decreasing popularity are:

• the limited liability company (LLC),
• the corporation,
• the LP, and
• the LLP.

First, U.S. tax advisors’ general rule is that you should never use a corporation to hold title to U.S. real estate, especially a corporation taxed as a C corporation because of the double tax that applies to entities taxed as C corporations.  If an entity taxed as a C corporation has taxable income, it must pay tax on that income at the entity level and then when the net proceeds are distributed to the owners, the owners pay a second tax on that income.

That narrows the entity choice to an LP or an LLP.  An Arizona LLP and an Arizona LP must have at least one general partner and one limited partner. The general rule of Arizona law is that limited partners of an Arizona LLP and LP are not liable for the debts or obligations of the entity. However, Arizona law provides that all GPs of an Arizona LP are 100% liable for the debts and liabilities of the LP. This a a very bad thing and a reason a person should never be the GP of an Arizona LP.

An Arizona LLP is essentially the same as an Arizona LP except that the general rule with respect to the liability of the general partner(s) of an Arizona LLP is the opposite of the general rule of liability for a general partner of an Arizona LP. The general rule of Arizona law with respect to an Arizona LLP is that the none of the general partners of the Arizona LLP are liable for the debts and obligations of the LLP. There are exceptions to this general rule. For example, the GP of an LLP is always liable for it/his/her own acts and omissions.   This is true of LPs too.

The reason people say form an LLP instead of an LP is to avoid creating another entity to be the GP of the LP. In theory, two people could form an Arizona LLP and one person could be the GP and the other the LP and each could claim the protection of Arizona law provided by the general rule of no liability for the partners of an Arizona LLP. The problem with forming an Arizona LLP is that the LLP could inadvertently lose its status as an LLP in the future because the LLP fails to file an annual report with the Arizona Secretary of State.

All Arizona LLPs must file this annual report. If the LLP fails to file an annual report, the Arizona Secretary of State will revoke its LLP status and then the LLP then becomes an LP and the general partner becomes personally liable for the LLP’s debts. This would be awful for the person. In my experience as a business and real estate lawyer since 1980, it is very common for companies to fail to file annual reports with the state, especially when the state does not send out a reminder that the report is due.

Because of the disastrous possibility of inadvertently losing LLP status, I do not recommend that people form Arizona LLPs. Instead, I recommend that Canadians who want to own investment real estate in Arizona form an Arizona LP and a new Arizona LLC to be the sole general partner of the LLP.  The GP/LLC would own 1% of the LP and be entitled to 1% of the profits and losses.  The set up costs are a little more when I form an Arizona LP because of forming two entities ($599 for the LLC plus $499 for the LP) plus there is the on going administration of two entities instead of one. You have to decide if the adverse Canadian tax consequences of using the Arizona LLC entity justifies the extra cost and admin of the LP with the LLC as a GP.

Related Articles

• Acquisition of US Real Estate, by Kim G C Moody of Moodys, LLP.
• Investing in the U.S. – A Guide for Foreign Companies, by KPMG, LLP.

Canadian & U.S. Investment Advisor

If you are a Canadian who is thinking about investing in the United States you should consult with Brian Wruk of Transition Financial Advisors Group, Inc., 20 West Juniper Avenue, Suite 101,Gilbert, Arizona 85233; phone: 480-722-941; fax: 480-812-2090.  Brian Wruk is a Certified Financial Planner™ specializing in Canadian residents making the transition to the US.  His firm, Transition Financial Advisors, Inc., is a fee-only, comprehensive financial planning, investment management, and Canada/U.S. tax planning and preparation firm. A dual Canadian/U.S. citizen, Brian holds both the U.S. and Canadian CFP® designations and is a Registered Trust and Estate Practitioner (TEP) with the Society of Trust and Estate Practitioners.  For more about Brian and his company, see the firm’s website.

Arizona LLC Attorney Richard Keyt’s LLC & LP Formation Services

If you are a Canadian who intends to purchase real estate in the United States, I would like to form your LLP or LP.  If your LLP or LP will own real estate outside Arizona,  I can form  an Arizona LLP or LP and register it to do business and own real estate in the appropriate state.  For information my Arizona LLC formation services, go to www.keytlaw.com/formllc.  See also the KEYTLaw girl’s explanation of why over 2,300 people have hired me to form their Arizona LLC.

KEYTLaw Girl Katie Leavitt

If you want me to form an Arizona limited partnership for you, call me at 602-906-4953, ext. 1 or send an email to me at rickkeyt@keytlaw.com.

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3. Arizona Corporation Commission Takes Action Against Sellers of Unregistered Real Estate Investments
4. Must an Arizona CPA form a PLLC?
5. Asset Protection: Doing Nothing Protects Nothing – Why People Form LLCs
6. Why Not Form a New Business as an LLC?
7. People in Control Are Personnally Liable for Unpaid Payroll Taxes of Companies
8. Arizona Court of Appeals Finds Officers & Directors of Arizona Corporation Personally Liable for Corporation’s Debt
9. Can an Arizona LLC be Owned Entirely by Non-U.S. Citizens Who Do Not Reside in the U.S.?
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