Are you one of those Canadians who cannot tolerate the cold, unpredictable winter and early spring? If you haven’t already done it, you have probably thought about purchasing property somewhere warm, such as across the border and due south.
Of course, I’m talking about Florida. The beaches of Naples, the night life of Miami, the tropical Keys; there’s something for everyone. And with a global recession at-hand, there will likely be plenty of affordable U.S. properties coming onto the market. The right property can be an escape for the entire family and friends. It can also be used to generate income, with the potential to cover operating expenses. But if you are thinking of purchasing a property south of the border there are some things you should know from a U.S. tax exposure stand-point.
First and foremost, avoid creating an LLC.
When it comes to Canadians purchasing U.S. property, especially if the intention is to use it fully or partially as a rental, you might be advised to create an LLC to acquire the property. This is a good vehicle for U.S. residents, but not so much for non-residents. The tax treatment for LLCs is quite different between Canada and the U.S. For a Canadian, this could result in double taxation and significant reporting obligations.
Ultimately, the format of acquisition and ownership of your U.S. property depends on many variables, including the intended use, timing of the ownership, the price of the property, your overall wealth, etc.
Pay attention to the length of your stays to avoid U.S. taxes on your Canadian income.
If you are trying to avoid the Canadian weather and plan to spend as much of the winter months in the hot sun as possible, it’s important to consider your days of U.S. presence. If you stay at your U.S. property for 183 days or more in any calendar year, you could become a U.S. resident for tax purposes. While the Canada-U.S. Tax Treaty should protect you if you exceed the 182-day threshold, the Internal Revenue Service (IRS) will require complicated and costly reporting and information returns.
Even if you avoid the 182-day threshold in a single calendar year, you can still be deemed a U.S. resident for tax purposes if you meet the ‘substantial presence test’. You don’t have to perform the calculation. That’s what your tax practitioner is for. But at a high level, you would add up the number of days you’ve spent in the U.S. over a three-year period where 100% of your days in the U.S. are included for the current year (for as long as you had at least 31 of them) and then only 1/3 and 1/6 of days in spent in the U.S. are included for the two preceding years, respectively. For as long as you maintain a home and your “nearest and dearest” in Canada and file Form 8840 by its due date every year disclosing your U.S. days and ties to Canada, you should be able to avoid U.S. taxation and reporting on a worldwide basis.
Planning to rent? You will have to pay tax on the rental income.
If the U.S. property is to be rented out, you will have U.S. filing requirements, even if the property generates losses. The IRS either requires a 30% withholding tax against the rent you are paid (without the benefit of deductions), or you must file a U.S. non-resident tax return due June 15 in order to claim expenses and any resulting losses. Without a U.S. non-resident tax return, the gross rents are subject to a 30% tax that is required to be withheld by the tenant or the payor of the rent.
When the U.S. property is sold, generally, 15% of taxes have to be withheld from the total proceeds. This is a temporary tax and all or some can be recovered when a US non-resident tax return is filed the following year. The Canadian can elect to reduce the withholding tax by applying for a “clearance certificate” with the IRS to limit the withholding tax to the maximum rate of tax applicable to the gain, if any. The application has to be made before closing of the sale.
Also watch out for the state income tax requirements. While some popular states do not impose income taxes on individual payers, (e.g. Florida, Texas, Nevada, to name few), others may require an annual tax return if any gross rental income is generated from within the state. You may also be charged withholding tax on the sale of the property. These costs must be considered before one gets into U.S. home ownership.
Do what you can to limit your estate tax exposure on U.S. property
Canadians who own U.S. property may be exposing their estate to U.S. estate tax of up to 40% of the value of the U.S property upon death. However, this estate tax applies only if your worldwide net worth is more than USD11.58M, which is the 2020 threshold for exclusions from estate tax, adjusted yearly for inflation and extended to Canadians under the Canada-U.S. Tax Treaty. This threshold doubles if the property is jointly held with a spouse and is transferred to the spouse on death.
These generous thresholds are in effect until the end of 2025, after which time the threshold will revert back to pre-Trump Tax Reform (approximately half of the current threshold). Although with the current spending to revive the U.S. and global economy in the trillions, the 2026 threshold may be closer than we think. Even if you are under the threshold, there is still the requirement to file a U.S. estate tax return to clear the property title. And if you considered gifting your U.S. property prior to death, be wary of the potential for double taxation.
So, while the Sunshine State might look a bit less sunny after reading this, it all comes down to proper planning. If you have any questions about the best way to structure the purchase of U.S. property, give us a call at Hanson Crossborder Tax.
We work directly with our clients and cooperatively with a wide variety of professionals, including lawyers, accountants and investment portfolio managers who understand the complexities of multi-jurisdictional tax exposure and reporting.
Our objective is to help our clients navigate through the many requirements of various foreign tax regimes, and assist them with both U.S. and Canadian tax laws and compliance obligations.