Articles Posted in Canadian Real Estate Investment

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One of the perennial questions my Canadian clients ask me is how they should take title to their US real estate, usually a vacation home.  My answer is, it depends on a number of considerations, but the right choice probably involves a revocable trust specially drafted to hold US real estate.  But in any case, some thought has to go into the decision.  Thousands of dollars may be at stake if the wrong method of title is used.  The choice shouldn’t be made casually while signing escrow papers, which regrettably often happens.

The best way for Canadians, and foreign nationals in general, to hold US real estate depends on their plans for the property, its value, the owner’s age and net worth, whether the property has appreciated since it was purchased, the expectation of rental income, and what issues loom large for the owner (avoiding probate, escaping the US estate tax, selling the property with a minimum of capital gain, limiting personal liability).  Let me go over the basics.

  1. The Probate Issue.  A probate in Canada can’t transfer real property located in the US to the decedent’s heirs.  Neither a California court nor the local county recorder will recognize foreign court orders when it comes to US real estate.  So, if you are a Canadian and you own a vacation home in California in your individual name (or both the names of you and your spouse), when one of you dies you will have to probate the real property (the exception is property held in joint tenancy, discussed below).  Another probate will be required when the surviving spouse dies if the spouse hasn’t sold the property.  Probate is the process whereby a court oversees and orders the transfer of assets from a decedent to the decedent’s heirs.  Like any court process it tends to be time consuming, public, and involves significant attorney’s fees.  Most foreign nationals are wise to try to avoid it.
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Helped along by the depressed US housing market in the past few years, the Palm Springs, California, area has become a hot spot for Canadians to purchase vacation homes or rental property. Often the same property is used for both purposes: vacations for snow-weary owners, and rentals when they go back to Canada. With the year about to end, it’s a good time to go over the basic tax rules for Canadians who own or rent real property in California.

Assuming the Canadian owner doesn’t have a green card or hold other residency status, the tax implications of owning real estate in the US will depend on how the property is used and how often it’s used.

If the property is solely used as a vacation home – and never rented out during the year – there should be no US tax implications until the house is transferred, either by sale, retitling into a trust or business entity, or at the owner’s death. In our wireless connected world, Canadians who mix vacation with work while at the property need to be careful about running afoul of US federal and California state income tax rules, especially when it comes to the very aggressive California tax authorities and their rules about California source income. But that’s another topic.

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So the California Revocable Trust seems like a very practical ownership form for the Canadian (Great Britain or even the American from a state other than Cal) who wishes to see their heirs spared (and I do mean spared) the California court system, inlcluding the time and cost (probate). Is it true, however, that the contribution of appreciated property can lead to a payment of tax requirement?

Is There a Tax Required in Either Canada or the US Upon Contributing the US House to the California Revocable Trust?

Remember, there’s one of two times the trust will first own the property: either (a) at the inception of the house purchase (for example, Canadians Harriet and Thomas decide to purchase a La Qunita California home, they enter a 30 day escrow period- prior to the closing date, Harriet and Thomas simply inform their escrow agents that they plan to own the house as trustees of their California Revocable Trust- escrow complies, and as of Day 1 the Harriet and Thomas Trust owns the home); or (b) after the home has been owned for a while by Thomas and Harriet, the house is transferred to the trust-. Is there a tax in Canada (or the US) if the trust is deemed owner from Day 1? No, no tax in either country. But what about if Harriet and Thomas have owned the house for years, and then want to transfer it to their California Revocable Trust, does that cause a tax obligation in either Canada or the US? In the US, a transfer of a house owned by H & W to the H&W Revocable Family Trust is not a taxable transaction, so there is no US or California tax. But on their Canadian tax return, Harriet and Thomas have a different conclusion. When Harriet and Thomas transfer their La Quinta house they’ve owned for a few years to their new Cal. Revocable Trust, there very well may be a taxable event in Canada. The tax is based on the appreciation (if any) in the value of the house from when Harriet and Thomas originally bought it until today, the day of transfer to the trust. The appreciation is all speculative, of course, it’s not like there’s been a recent sale to prove there’s been an appreciation in the property. But presumably by reaching out to a local realtor, by checking in with their neighbor (or head of your homeowner’s association), or even by reviewing the recent state property tax bill, they can have a good idea whether the property has appreciated. If it has, they will likely pay a deemed disposition tax on their Canadian tax return, but no tax (or return) will be required in the US upon the transfer to the trust. But, see below for an exception to that rule…..

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More on When We Use the Canadian Irrevocable Trust to Purchase US Property…

So we pick up where we left off last week: super-wealthy Canadians who own more than $5.34M in worldwide assets, and who loathe the idea of paying a US estate tax, should consider (1st and foremost) putting the US house into a Canadian Irrevocable Trust. You can do this with relative ease if the trust owns the house from the inception. But be careful for the scenario where the Canadians own the house individually at first, and then transfer (usually via a sale) the house to a Canadian Irrevocable Trust later. This is thought by some (but by no means all) practitioners to subject to the Canadians to the US gift tax (even though it’s a sale). I’ve yet to see any evidence of this, except for indirect case law from 50 plus years ago, so who knows. Nonetheless, Canadians transferring a US house to a Canadian Irrevocable Trust after owning it individually first (as opposed to when the trust buys the US property first) should remain mindful they are taking a risk, and that IRS may impose a gift tax on this transfer (sale). Call us at Sanger and Manes (760-320-7421) to discuss the Canadian Irrevocable Trust for California (and especially) Coachella Valley properties. This is a highly complex cross-border estate planning area, but Sanger & Manes can help.

For the vast majority of Canadians purchasing US real estate, the biggest concern is not the US estate tax, it’s the excessive cost and time required for a Canadian’s heirs to inherit their parents’ California real estate- i.e. the cost of probate (the California process whereby a California court orders the Canadian snowbird’s US house to be distributed to their designated beneficiary(ies)).