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tax matters

As I was travelling to the United States this week I couldn't help but notice the number of snowbirds already starting their migration south to spend the colder months in warmer climes. I started a conversation with one couple who was heading to Florida in search of a vacation property they'd like to buy. We started chatting about the importance of getting advice to identify the optimal way to own a property south of the border.

Should you own the property in your own name, or in your spouse's name? Should you own the property in a trust, corporation, partnership or jointly with someone else? Each option comes with pros and cons. Let me share some of the current thinking.

The estate tax

When buying U.S. real estate, the greatest concern is often the dreaded U.S. estate tax. Your U.S. real estate (among other "U.S. situs property" – the technical term for assets subject to the U.S. estate tax) could face an estate tax in the U.S. of up to 35 per cent of the property value.

Now, Canada's tax treaty with the U.S. can reduce this tax hit for worldwide estates under a certain size – generally $5-million (or $10-million for those who are married and the property is transferred to your spouse on death). This high exemption amount is due to expire at the end of 2012 and is expected to be significantly less after this year.

As a general rule, it makes sense to assume the exemption amount (which does change from time to time) will be low and that you'll need to plan for a U.S. estate tax problem. Further, the treaty won't provide relief for larger estates since the tax credit that can offset the U.S. estate tax is prorated by the value of your U.S. situs property as a percentage of your total worldwide estate value. The lower the value of your U.S. property relative to your worldwide estate, the lower the credit you'll be entitled to claim.

The strategies

So, where do you start? If you own, or are thinking of buying, U.S. real estate, visit a tax pro to calculate your U.S. estate tax exposure. This should then dictate how you deal with the problem. As for your options, let me share a few ideas to minimize the U.S. estate tax. These ideas, by the way, are for Canadian residents. If you're a U.S. citizen, resident or green card holder, different planning may be required.

1. Spouse with lower net worth: The lower your net worth, the less likely you'll be concerned about the U.S. estate tax because a net worth below the exemption amount won't generally attract a U.S. estate tax bill. As a result, it makes sense in many cases to place ownership of U.S. property in the name of the spouse with the lower net worth. It's important that this spouse use his or her own funds to purchase the property to avoid a tax problem.

2. Use joint names: By placing a U.S. property in two or more joint names, your U.S. estate tax exposure can be minimized . Now, if you own the property jointly with right of survivorship then the property is deemed to have been owned entirely by the first joint tenant (owner) to die – unless the surviving tenant can prove he used his own money to buy his share of the property. So, it's important that each individual, including spouses, keep evidence that they used their own funds to buy their share of the property.

3. Arrange non-recourse debt: If you own a U.S. property and there is non-recourse debt secured by the property, then the amount of the debt will reduce the value of the property subject to estate tax on your death. "Non-recourse debt" is simply debt where the lender can seize the property in the event you default on your payments, but can't seize other assets. Now, it's not always easy to find a financial institution to lend on this basis, so it may make sense to use your spouse as a source of non-recourse financing. It's important that the debt be registered and have commercial terms and the loan-to-value ratio must also reflect normal standards. I'll continue this topic next time.

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