by KeatsConnelly, CPAs
1. Owning Property in Personal Name
When purchasing a property in the US there are several different ways to take title. Some may sound familiar, e.g. Joint Tenants, but as buyers, you will need to understand how each different method can work for or against you. For example, if not purchased properly, Joint Tenants with Rights of Survivorship can have adverse estate tax effects on the survivor, whereas Community Property or Tenants in Common may prevent these adverse estate tax effects, regardless of the source of the funds used to purchase the property. With the proper advice, you can sidestep costly mistakes and take advantage of the some opportunities.
Another consideration is liability exposure. If you are renting your property, you are exposing yourself to more risk than if you occupied the home yourself. When taking the title in your own name, you are personally responsible for any liability issues that arise. Although you can purchase insurance to protect yourself from some liability, your liability is unlimited and the insurance coverage may not be enough to cover the liability, whereas using a business entity may limit your liability.
2. Owning Property Through a Foreign Company
This is one of the most common mistakes that people make when purchasing property in the US. While you may desire to keep all of your investments within one entity, the very act of owning US real property within your company causes additional tax filing requirements and can cause adverse tax results, including potential double taxation. In the rare occasion that the benefits of owning property in a Canadian entity, out weighted the cost; this is the exception to the general rule and should not be considered without the proper cross border tax advice. Additionally, there could jurisdictional disputes that would increase your legal fees.
3. US Business Structures
How do you protect yourself against the liability associated with an income producing property, e.g. rental property, yet not have the double tax or burdensome tax reports that are associated with a foreign entity? Deciding between which business structures to use, can be the difference in having positive or negative cash flow. The optimum tax structure will depend on three sets of laws: US tax law, your home country’s tax law (Canada), and the US-Canada tax treaty. Without looking at the ramifications in each of these three separate taxing authorities, you run the risk of getting hit with a double tax, additional taxes, additional tax filing, and the aggravation, time and money it takes to correct the corporate structure. Doing it right the first time is critical!
4. Income Tax
Once you own real property in the US you may have a tax filing and liability in the US attributable to this income. If the property that you own produces any revenue, e.g. rental income or capital gains on sale, you will be required to file a non-resident tax return by June 30th the year following the creation of the income. For example, if you sold your US property in 2011, then the income tax return is due by June 30, 2012. However, you will want to file early so your Canadian accountant can file the Canadian return and take the appropriate tax credit.
Each owner of the property needs to file a separate tax return to report their share of the gain (or loss) on the property. Even if you have a loss on the property either from rental income or on sale, you still are required to file the tax return. However, as a general rule any taxes that you pay to the US, will be a credit in Canada when you file your Canadian T1.
5. Estate Tax or The Death Tax
The US estate tax is computed on the Fair Market Value (FMV) of the assets at the time of death. Therefore, even if the home is worth less than what you bought it for, you still could have a US estate tax liability. As a rule, non-residents of the US are allowed to exempt US$60,000 of their US assets from estate tax, US$120,000 for married couples. Under the US/Canada Tax Treaty Canadians are allowed a pro-rata amount of US resident exemption, which is currently US$5,000,000 (2011 & 2012), but it goes down to $1,000,000 after 2012 unless Congress changes the exemption amount. In many cases, the pro-rata amount is sufficient to exempt US property from US estate tax.
Owning the property through an entity may sidestep the estate tax issue since, unlike people, entities do not die. However, because the ratio is both subject to change and extremely dependent on each individual situation, it is very important to review your circumstances with a qualified cross-border tax professional to ensure that you fully understand all the ramifications.
The US is generally more litigious in nature than other countries, including Canada. Because of this, you will want to ensure that you have adequate liability protection for both your personal use properties and your investment properties. Generally speaking, investment properties involve more risk than personal use properties, because other people will be staying in them. Owning the property through an entity may stop your personal exposure to liability, but depending on the cash flow of the property, holding period and other factors there many less expensive ways to protect yourself and assets from liability risks.
An inexpensive way of mitigating your exposure is to purchase an excess risk (umbrella) policy in addition to the liability coverage that is built into regular homeowners properties.
7. Cash Flow
If you are purchasing an investment property you want more revenues than expenses, otherwise why do it? One common expense that is forgotten is the amount of accounting and tax preparation fees. Without advance careful planning, the cost of tax return preparation could equal any profit or gain that you have made. You need enough cash flow to support the structure that you develop. For example a simple Limited Liability Partnership return can cost $1,200 or more. If you only have one single family home in the partnership and you gross $1,000 per month, than you have just spent 1/12th of your gross rent just to support your corporate structure, and you still have to file a personal tax return for each of the partners. If you are buying multiple properties, there may be ways to structure the purchases in an overall more cost effective manner.
8. Qualified Advice
Purchasing property in another country presents several challenges, not least of which are the repercussions on your tax situation in your home country. As explained before there are three sets of laws that you be concerned about. The person giving the advice should have some knowledge and (preferably) experience of the three taxing authorities (US tax law; Canadian tax law; US-Canada tax treaty). There are too many instances of clients relying on advisors who did not fully understand this area of tax and incurring unnecessarily thousands or hundreds of thousands of dollars in professional fees, taxes, and tax filings.
A common recommendation of US advisors is to set up a Limited Liability Company for Canadians. From a US standpoint this is a sensible recommendation, but because the US advisor does not understand the Canadian tax issues, they are unaware of the double tax situation created for the clients. Whereas a qualified cross-border advisor will be able to ask all the right questions and be able to discuss the implication on both sides of the border and prevent the adverse effects of this type of mistake.
9. Foreign Investment in Real Property Tax Act of 1980 (FIRPTA)
Foreign Investment in Real Property Tax Act of 1980 is a law that was designed to ensure that nonresident persons who have a US tax liability on appreciated US real property pay these taxes. When a nonresident person (or entity) sells US real property, FIRPTA requires a 10% withholding tax based on the gross selling price. However, certain forms can be filed before the close of escrow that can reduce the withholding to 10% of the gain, rather than on the sales price. Further, withholding does not apply to all sales transactions.
Often the title companies, who manage the withholding, do not fully understand the rules and apply them incorrectly. If this happens, the sellers cannot get their money back until they file tax returns the following year. This is an area where if you do not know the rules or you do not have a qualified advisor helping you through the process, it can be difficult to get answers on the timely basis required to prevent an unnecessary loss of access to your money.
10. Don’t Let The Tax Tail Wag The Investment Dog
When purchasing US property, non-US persons often get so bogged down with the tax implications that they lose focus on the big picture. Taxes are important, but they are the tail of the animal that we call investing. As long as you have hired a qualified cross-border advisor, they should be able to guide you through the maze of issues to give the best tax result. You can focus on what you do best and let KeatsConnelly help you with the planning and tax advice.
Contact Dale Walters, CPA
3336 N. 32nd Street, Suite 100
Phoenix, AZ 85018-6241
Phone: (602) 955-5007
Fax: (602) 224-5874