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We’re taking a break from speaking about the FBAR amnesty program (we will return to this topic shortly), but were going to continue to parallel (for now) our Canadian Snowbird Blog. So the topic at hand is how do I sell my house (we’re assuming the house has gone up in value), buy a new house, and not pay tax? Let’s assume, for the sake of discussion, that I sell a La Quinta home which has appreciated in value by $500,000 since I bought the house in 1997.

Question #1- Can I sell the house in La Quinta (for $500k more than he bought it for) and buy the Palm Desert replacement property without paying any US tax?

The general answer is yes. Internal Revenue Code Section 1031allows me to exchange, tax free, US real property for other US real property, if several requirements are met.

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We’ve been on a little bit of a break for the busy “season” of February, March and into April. Let’s also take a break from talking about the FBAR amnesty program (we will return to this topic shortly).

A question we frequently get comes from a Canadian snowbird who owns (for example) a house in La Quinta. The Canadian then wants to sell the La Quinta property, and purchase a Palm Desert property to take its place. Let’s assume, for the sake of discussion, that the La Quinta home the Canadian snowbird is selling has appreciated in value by $500,000 since the snowbird bought the house in 1997 (we will think optimistically).

Question #1- Can our Canadian citizen sell the house in La Quinta (for $500k more than he bought it for) and buy the Palm Desert replacement property without paying any US tax?

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We’re speaking about US citizens or residents (and US tax residents can be citizens of any country who happen to stay in the US too long in a given year, this could be citizens from any country outside of the US who may visit Palm Springs, or Rancho Mirage or Palm Desert long enough for a given year that they are deemed a US tax resident; we are also speaking of citizens of foreign countries who are US green card holders). US citizens and residents must declare to the Department of Treasury their foreign bank accounts (provided they have over $10,000 in aggregate foreign bank accounts/ assets…not a high bar). They must file these information returns (called “FBARs”) by June 30 of each year. Many US citizens and tax residents (particularly those who are current or former citizens of another country) are unaware of the FBAR requirement, which was enacted in 2003. That is why the IRS amnesty programs can be so valuable. In 2012, the IRS is again offering a FBAR amnesty program. This is the third such amnesty program. There is no guarantee there will be a fourth.

Structure of the IRS Amnesty Program

Although the IRS has yet to provide (much) specific guidance on the 2012 amnesty program, it will almost certainly follow the framework provided in the 2011 program. So it makes sense to review generally the 2011 program (the “OVDI Program”). Taxpayers who made voluntary disclosures under the 2011 OVDI Program could expect the following penalties/payments:

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We’re speaking about US citizens or residents (and US tax residents can be citizens of any country who happen to stay in the US too long in a given year, with special attention paid to in this blog Canadian citizens who may visit Palm Springs, or Rancho Mirage or Palm Desert long enough for a given year that they are deemed a US tax resident; we are also speaking of citizens of foreign countries who are US green card holders). US citizens and residents must declare to the Department of Treasury their foreign bank accounts (provided they have over $10,000 in aggregate foreign bank accounts/ assets…not a high bar). They must file these information returns (called “FBARs”) by June 30 of each year. Many US citizens and tax residents (particularly those who are current or former citizens of another country) are unaware of the FBAR requirement, which was enacted in 2003. That is why the IRS amnesty programs can be so valuable. In 2012, the IRS is again offering a FBAR amnesty program. This is the third such amnesty program. There is no guarantee there will be a fourth.

Structure of the IRS Amnesty Program Although the IRS has yet to provide (much) specific guidance on the 2012 amnesty program, it will almost certainly follow the framework provided in the 2011 program. So it makes sense to review generally the 2011 program (the “OVDI Program”). Taxpayers who made voluntary disclosures under the 2011 OVDI Program could expect the following penalties/payments:

Path One- the No Questions Asked Path requires the taxpayer to pay 27.5% (for the 2012 program…under the 2011 OVDI Program it was only 25%) of the highest aggregate overseas account balance in the highest year. So if the aggregate overseas account balance in the highest year (when the individual did not file a FBAR) was $2,000,000 (and by the way, when we say highest aggregate overseas account balance we are including the value of overseas assets- such as a house- plus the value of overseas accounts), the individual is volunteering to pay a penalty to the IRS of $550,000 (27.5% x $2,000,000), plus the unpaid income tax (if any), plus penalties for failure to file or pay income tax (if any). So, under Path One, the easy/no risk path, the individual with undeclared overseas accounts (and assets) of $2,000,000 must pay a penalty of $550,000 at an absolute minimum…THIS IS A STIFF AMNESTY PENATLY!!!

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In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents must file a “FBAR” (a “Report of Foreign Bank and Financial Accounts”) annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

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In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

Canadian Snowbirds Who Are US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents (i.e., Canadians who are in the US a little too much in a given year) must file a “FBAR” (a “Report of Foreign Bank and Financial Accounts”) annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. Canadian snowbirds will likely have no shortage of these back in Canada. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

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We’ve discussed previously how, if the Canadian visitor to Palm Springs is not careful, he or she can inadvertently find themselves subject to US taxation on income earned anywhere in the world (worldwide income). In any calendar year in which a foreign citizen stays in the US over 183 days, the person may become subject to tax in the US on their worldwide income (the person may become a US resident for tax purposes at least for that year, but the US-Canada Tax Treaty does offer potential relief for the Canadian citizen being deemed a US tax resident in this scenario). Also recall that if over a three year period the Canadian citizen is in the US so much that he or she fails the “substantial presence” test (and does not file the closer connection Form 8840…big mistake), the individual may also be considered a US tax resident for that year. On the plus side, even if the Canadian is deemed a US tax resident for the year and the US taxes the Canadian citizen on all his or her worldwide income, there’s a good chance Canada will credit most (if not all) the US taxes paid. So for the Canadian who stays a little too long in the US there probably won’t be much, if any, double tax between the US and Canada (although the individual could easily end up paying the higher rate of tax between the two countries).

What else does being a US tax resident for a given year mean? Many people are surprised to find out it means you must provide the US Department of Treasury information about all your foreign bank accounts. Well, for the Canadian snowbird visiting the Coachella Valley, there’s a good chance most if not all his or her bank accounts are in Canada, so this becomes a significant required disclosure.

US Citizens or Tax Residents Must File a FBAR Annually

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So let’s get into some real detail on the US estate tax, and how the IRS imposes it on Canadians with homes and other assets in Palm Springs (and the entire US). The estate tax is imposed only on the value of US assets (not the value of worldwide assets) of Canadians (provided they are not “domiciled” in the US). This will be most Canadian snowbird visitors to the Coachella Valley. But is it imposed on every dollar’s worth of assets a Canadian dies with in the US? No. Canadians (and Americans) are permitted to exclude a certain amount of assets from the estate tax.

How Much Assets May an American Exclude From the Estate Tax?

For 2011 and 2012, American citizens and residents may exclude their first $5M in worldwide assets (notice the distinction again here as Canadian snowbirds will only be subject to the estate tax on their US assets). What this means generally is that an American who dies in 2012 with $2M is total worldwide assets must recognize $0 estate tax. And, as you will see, a Canadian who dies in 2012 with $2M is total worldwide assets (even if they’re all in the US) must also recognize $0 estate tax.

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In a previous post, we introduced the concept that Canadians with property located in the US are potentially subject to the US estate tax upon their death. This is true even though the Canadian snowbird may never spend enough time in the US to make themselves US residents for tax purposes. In fact, this can be true of the Canadian who spends almost no time in the United States. That’s because the US levies its estate tax on a foreign citizen’s property located in the US. Ultimately, it’s the US location of the property that matters. But note, not all property located in the US is included in the estate tax computation.

What’s Included?

Canadians are generally subject to US estate tax on their assets located within the US (US “situs property”) upon their death. The following types of property constitutes US situs property for the purposes of the US estate tax:

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A district court has now granted the IRS permission to issue a summons to the State of California Board of Equalization, as part of a gift tax enforcement initiative to detect transfers of real property between nonspouse relatives that weren’t reported on gift tax returns. California now joins Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin, as states where the state governments must turn over records about property transfers to the IRS. If you transferred property to nonspouse relatives and did not complete the appropriate gift tax return, the State of California may be on the verge of telling the IRS all about you.

Gift Tax Background

Intra-family transfers of property are extremely common. Remember that in 2011, decedents can exclude up to $5 million of their estate before having to pay estate tax on the remainder. Likewise, in 2011 individuals can “gift” up to $5 million and not pay a tax on the gift amount (the Internal Revenue Code therefore “unifies” the estate tax and the gift tax.) However, any individual who makes gifts to any one donee during a calendar year above the $13,000 annual exclusion must file a gift tax return (an IRS Form 709). A return must be filed even if no tax is payable (due to the $5 million lifetime exclusion).