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 opportunities.
Florida is one of the states that allow tenancy by the entirety as a method of home ownership. The primary difference between tenancy by the entirety and joint tenancy is that joint tenants may deal with the property as they wish. One joint tenant decides to convey his or her interest in the property without the other tenant’s permission. In tenancy by the entirety, each member effectively owns the entire property. Therefore, neither can deal with the property independently of the other.
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.
Buy US real estate in a Canadian company 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 doing 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.
While Florida does not have a personal income tax, it does impose tax on corporations. By using your Canadian corporation, you will be required to file a nonresident US and Florida corporate tax return. Florida imposes a flat 5.5% tax on corporate income. The federal corporate tax rates are graduated depending on income and can be as much as 39%.
Even many US entities will cause Canadians to be double taxed. Common entities that cause double tax are corporations and Limited Liability Companies (LLCs). 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!
Once you own real property in the US, you may have a tax filing requirement in the US if the property is used in a trade or business. If the property is strictly a second home, there will be no tax filing requirements until the home is sold, at that point, you will have to report the capital gain. When the property produces revenues, e.g. rental income or capital gains on sale, you will be required to file a nonresident tax return by June 30th the year following the creation of the income. For example, if you sell your US property in 2014, then the income tax return is due by June 30, 2015. However, you will want to file early so that 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. Just because you have loss, does not mean you do not have to file, 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.
The US estate tax is computed on the Fair Market Value (FMV) of the assets and not the Capital Appreciation. Therefore, it does not matter if the home is worth less than what you bought it for, you still could have a US estate tax liability. As a rule, nonresidents of the US are allowed to exempt US$60,000 of their US assets from estate tax or 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$5,340,000 (2014). In many cases, the pro-rata amount is sufficient to exempt the second home from estate tax.
Owning the property through an entity may sidestep the estate tax issue on the personal level. However, because the ratio is extremely dependent on each individual situation it is critically important to review your circumstances with a qualified cross border tax professional to ensure that you fully understand all 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 as well as your investment properties. Generally speaking investment properties have more risk than personal use properties, because you have other people staying on the property. Owning the property in an entity may stop the liability exposure personally, but depending on the cash flow of the property, holding period and other factors there many cheaper ways to protect yourself and assets from liability risks.
If you are purchasing an investment property you want more revenues than expenses, otherwise why do it? There are several drags on cash flow. One common expense that is often forgotten about one is the accounting and tax preparation fees. Be sure to create a structure that will suit your situation, but be careful of advisors suggesting overly complicated structures. In addition to the extra cost to set up, you will have ongoing tax filing requirements that might be avoided by using a more simple structure.
It should be obvious that you are entering into a complicated transaction worth a lot of money; you should seek out competent cross border tax advice. The person giving the advice should be able to address the most if not all the different taxing authorities. There are many examples how clients relied on advisors who did not understand the different area that cost them thousands or hundreds of thousands of dollars in professional fees, taxes, and tax filings.
As mentioned earlier, a common recommendation of US advisors is to set up a Limited Liability Company for Canadians. From an US standpoint this is a perfectly good recommendation; however, because the US advisor does not understand the Canadian tax issues, they are unaware of the double tax situation they just created for their 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.
Foreign Investment in Real Property Tax Act of 1980 is a law designed to ensure that nonresidents that have a tax liability on appreciated US real property pay their taxes. When a nonresident person sales 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.
Many times the title companies, the people who handle the withholding, will not understand the rules and try to apply the rules unnecessarily. If this happens, the sellers cannot get their money back until they file the tax returns the following year. This is one of those areas that if you do not know the rules or if you do not have a qualified advisor helping you through this process, it can create frustration and cause an unnecessary loss of access to your money.
When purchasing US property, non-US persons often become so bogged down with the tax implications that they lose focus on the big picture. These things are simply business transactions whereby you invest some time upfront to determine how to structure things, after which you can go make money. 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.
There are three ways we can help you with your questions regarding buying real estate in the US.
- Book titled Buying Real Estate in the US: The Concise Guide for Canadians:
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