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tax matters

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.

It was my wife Carolyn's birthday last week. Somehow I manage to mess up the gift-buying process every year. This problem dates back to the first year we were dating. She was expecting an engagement ring, but I bought her a cellphone instead.

"It was the wrong kind of 'ring'" she told me just a week ago. "But it came with a three-year contract, showing a lot of commitment," I replied.

This year, I bought her a gift that I now know was only slightly higher on her wish list than a sink plunger. I bought her an Elvis clock. She really does like Elvis, so I'm not sure what the problem is.

She told me this week that when she turns 60 (we've got quite a few years to go still), she'd like a place in Florida for her birthday. She's giving me advance notice so that I can plan ahead of time.

The toughest part of planning a U.S. property purchase is how to structure the ownership. Since many snowbirds are now starting to head south, and many will purchase properties in the United States this year given the still-low prices (in some regions) and a strong Canadian dollar, let's talk about some tips and traps related to structuring ownership in a U.S. vacation property.

The concern

The big concern for Canadians looking to buy real estate in the United States is estate taxes south of the border. Even if you're resident in Canada and not a U.S. citizen, you could be liable for U.S. estate tax on any U.S. assets that you own at the time of your death – and U.S. real estate is a notable problem because the U.S. estate tax liability can be significant without proper planning.

U.S. real estate can also give rise to a gift tax problem in that country if you make a gift of a U.S. property to someone during your lifetime. All of this means that a visit to a tax pro to structure your ownership properly will be important. When you make that visit, have a conversation about the following tips and traps:

The strategies

  • Avoid using a corporation. Prior to 2005, many Canadians held their U.S. real estate in a Canadian corporation – often called a “single purpose corporation.” A corporation doesn’t die, of course, so there’d be no U.S. estate tax levied on the property when the shareholder of the corporation died. For Canadian tax purposes, the taxman used to allow these corporations to exist without assessing a taxable benefit on the shareholder for personal use of the property. No longer. CRA will now assess a taxable benefit equal to the fair market rent on the property each year. This makes corporate ownership a bad idea today.
  • Avoid joint ownership. If you’re thinking of holding your U.S. real estate jointly with your spouse to split the U.S. estate tax bill, think again. When the first spouse dies, and the surviving spouse is not a U.S. citizen, the U.S. estate tax will apply to the full value of the property (unless you can prove that each contributed financially to the purchase). Even worse, the estate tax will be owing a second time on the full value of the property when the second spouse dies. Further, if you sell the property during your lifetimes, the Internal Revenue Service (IRS) could assess a gift tax on any proceeds received by a spouse who did not contribute equally to the purchase.
  • Consider a partnership. Using a Canadian partnership to own your U.S. real estate is viewed by some to be a reasonable method of avoiding the U.S. estate tax. There may be more risk that the IRS will look through a partnership structure to assess the estate tax on the partners personally. Under the law of your province, a partnership may be defined as a relationship between parties carrying on business with a view to a profit. Does a personal vacation property give rise to meeting this definition? Speak to a tax pro about the risks.
  • Consider ownership by a trust. Using a trust to hold your U.S. real estate is a great way to avoid the U.S. estate tax. The trust needs to be set up before you acquire the property and the property should be acquired by the trust from the outset to avoid complications. It’s often wise to avoid earning rental income on the property held by the trust to avoid U.S. tax filing requirements and to ensure that no taxable benefits are triggered.

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