Articles Posted in Cross-Border Taxation

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congress-e1521771059150-300x231The tax legislation passed by Congress last year is something of a 1950s pop love song to businesses: sweet but not very deep.  It will likely have little impact on Canadians unless they own and operate a US company.  Typically, Canadians invest in US assets, particularly real estate, rather than run US operations.  The tax package has little to offer in that regard.  But one change does make a difference.  The new law doubles the US estate tax exemption amount.  Given the size of the increase, the US estate tax now leaves all but the wealthiest Canadians untouched.  However, this situation is temporary, making long-term estate planning for Canadians with US property tricky.

Canadians And US Estate Taxes

Canadians who own US assets (typically a vacation home) have traditionally been paranoid about US estate taxes.  It’s understandable.  The US estate tax rate has lurched between 35% and 65% in recent history, with a current rate of 40%.  Before 2003, when the exemption amount was $2 million or less, the estate of a Canadian with a valuable vacation home in the US could easily get hit with a significant estate tax.  Still, the anxiety was always exaggerated, given the favorable treatment Canadians receive under the US-Canada Tax Treaty.  This is especially true after 2010, when the exemption shot up to $5 million, with annual upward adjustments.

How The Treaty Works

The Treaty provides Canadians with the most favorable estate tax treatment of any US tax treaty.  Besides mitigating double taxation by providing for a deduction for Canada’s equivalent of an estate tax (the “deemed disposition” tax), the Treaty allows the estates of Canadians to benefit from the exemption amount available to US citizens.  The exemption is prorated based on the ratio of the value of taxable US assets to the value of the worldwide assets owned by the decedent.  To use simple numbers, if a Canadian died in 2011 when the exemption was $5 million, and his total assets were $5 million, with a vacation home located in the US worth $2.5 million, the estate would apply a percentage of the exemption amount equal to the US asset value over the total asset value. Result: a $2.5 million exemption against a US estate worth $2.5 million.  Accordingly, the estate would owe no estate taxes. Continue reading →

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shutterstock_341354720-sm-jpg-300x185-300x185One of the major concerns of Canadians holding US real estate or other assets is whether the property will be subject to the US estate tax when they die.  It’s no small matter.  The estate tax top rate is 40%, and unlike Americans, foreign nationals who own US assets generally only qualify for a paltry $60,000 estate tax exclusion amount, not the $5.5 million unified credit available to American citizens.  Theoretically, if no planning were done and a foreign national died with a US vacation home worth $1 million, his estate would owe about $322,000 in US estate taxes.

Just as important, while American citizens have the benefit of the unlimited marital deduction when they leave their estate to a spouse (which is the typical estate plan), noncitizen couples cannot make use of the marital deduction to reduce or eliminate US estate taxes (unless they establish a QDOT, discussed below).

Fortunately for most Canadians, however, the US-Canada Tax Convention and its protocols, come to the rescue, if they plan right.  Here’s how.

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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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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)).

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Summer allows us a little break in our Palm Springs law office, and it also allows us to take a break from our blogs. But as Fall is now upon us (and it is gorgeous outside, trust me), it’s time to get back to business. We get a a lot of questions about the probate process here in California (something our Firm gets involved in regularly), and how it may differ when the deceased was not a US citizen/ resident.

Before We Describe the Probate Process, Remember, Your Estate Will Save Time and Money if You Put Your House in a Trust While You’re Living

California probate is a both time consuming (think 8 months to over a year to complete…) and costly (the family of a deceased will have to pay attorneys approximately 3% of the value of the property being probated in California…plus extra costs as well associated with the estate tax return of the estate and even potentially other costs). On the other hand, property placed into a valid trust (under California law) does not have to go through probate, which generally saves the estate thousands of dollars and speeds up the process by which the heirs receive the property considerably. Sanger and Manes drafts trusts for Canadians owning Palm Springs area real estate (and all of California property generally).