Many Canadians dream about buying real estate in the U.S. Sun Belt, but most will spend more time thinking about the sunshine than the tax implications. Chris Gandhu, High Net Worth Planner, TD Wealth, talks about what you need to know tax-wise before you make that dream purchase.
Print Transcript
- Well, cold Canadian winters and spring-- and who knows, even summer; it's been a tough one-- have led many to think about buying property in the US Sun Belt. But while sunny climates in Florida, Arizona may seem appealing, there are serious tax implications for Canadians buying property in the US. I spoke earlier with Chris Gandhu-- he's a High Net Worth Planner with TD Wealth-- about the type of challenges a Canadian buyer can face and needs to think about.
- Let's imagine there's Bob, a retiree, owns property in Palm Springs, California. Now, Bob's heard that probate in California's a bit messy-- not far from the truth. So he decides to do a probate maneuver. He puts his daughter on title as a joint owner of the property. It works for probate planning, not very different than what would be done in Canada. But from a tax point of view, it's a terrible move.
- Why?
- Well, first of all, US has a gift tax concept. So now the daughter's on title and she hasn't paid anything for the property, so Bob has made a gift to her. Top tax rate-- 40%. On the Canadian side, we actually have a disposition. It went from one owner, now to two owners. So we have capital gains tax in Canada, and to make it worse, Canada does not offer a credit for the gift tax paid. So he's looking at US gift tax, Canadian capital gains tax, and the daughter has actually acquired her interest in the property at her father's-- Bob's-- historical cost base. So in the future when she sells it, she's looking at US capital gains tax, or a triple whammy with a small planning error.
- Yeah. Small planning error-- very, very costly planning error. OK, and also for context, these are people who are looking to buy property with a longer term vision-- like, to have it stay in the family a little longer.
- That's exactly right. I mean, if you're looking to buy it to flip it, some different context.
- OK. So let's start with, again, long-term, looking to buy something. How do I avoid what just-- you told us about?
- To be very frank with you, it's difficult to avoid everything. But if you're proactive, you can certainly plan around many things. So in the cross-border context, it is a very complex puzzle, and it's important to have advisors who are familiar with the issues and can advise you appropriately based on your facts and circumstances. Let's take another example.
Historically, the most common issue facing Canadians purchasing US real estate has been US estate tax. And US estate tax is terrible, because A, it's a fair value tax so it doesn't correlate to any gains or losses. It's strictly a property transfer tax. The tax rate is very high at 40%. And it also applies at each death.
So if I own property when I die and pass away, there's potentially a 40% haircut then. If I bequeath the property to my spouse and she dies, there's another 40% haircut then. So it's a terrible tax. But guess what? In 2019, the exemption is a very generous 11.4 million US dollars-- so maybe about 15 million Canadian.
So are you really affected by this if your net worth is below that number? Of course not. Maybe you have to file, but you won't have to pay tax. But then again, if I say that, I can also tell you right now California has a bill on the table where they're looking to implement their own state-specific estate tax. So maybe it was an issue. It's no longer an issue today, but it might be, again, an issue for those people purchasing in California. And you can't expect every person to be on top of this. You would need advisors who can guide you appropriately.
- You're scaring me off doing this all together at this point. So that's the estate tax. What probate issues?
- Right, so probate, Kim, is really a validation of the will. And probate can be a challenge because of the delay and the cost involved. The delay, because if you have a Canadian will, it will be probated in Canada first, and only then submitted for probate in the foreign jurisdiction. Cost because you're looking at paying legal costs in Canada and, of course, legal fees in the US, and potentially court fees in the US. So I think you take a facts and circumstances approach and see if probate and the costs associated with it are an impediment.
If they are not, probate planning might not be your priority. If probate planning is a priority, you certainly can do something, but as long as you approach it with caution. So going back to our example with Bob and the daughter, that wasn't a very good example of probate planning.
If you wanted to, for instance, put your spouse on title, understand that there is a US $155,000 annual exclusion from gift tax. So potentially, probate planning is easier between spouses. Not so easy when we're looking at parents to children.
- OK, let's say that, then, I've talked to you or talked to somebody qualified. I figured the probate side of things. I'm under the threshold, so I'm fairly comfortable on that in terms of the future. Should I go ahead, then, and bid on a dream property? What's the next step?
- Life is way too short, so if that's your dream, you absolutely should, Kim. What I will say is this. First of all, before you plan to purchase, know who will own the property. Is it going to be you? Is it going to be your spouse? Or is it going to be somebody else? And know how you'll own the property.
How will you hold it as a title-- solely in your name, as a joint tenancy, as a tenancy in common? Are you using a trust structure? So answer that beforehand. It's sometimes too late to plan for it after the fact. And of course, understand that even if you're owning enough for the long-term, if you do choose to sell it a few years later, there'll be US capital gains tax. Of course, as a Canadian resident, you also report the gain in Canada.
We should have an offsetting foreign tax credit, so it shouldn't be double-taxed, but sometimes a foreign exchange does cause a bit of tax leakage. And finally, US will automatically impose a 15% withholding tax when you sell that property. So for the larger properties, there could be a cash flow issue.
- What if I want to make it more complicated-- I buy the property, and then, you know what? I'm not there all the time. I'd like to rent it out some of the time. What does that cause?
- Right. So if you are a landlord earning rental income in the US, most certainly you have to pay tax on that, right? So your easiest option is to do nothing, and the tenant is then obligated to withhold 30%, submit that to the IRS, and you're free and clear, no tax return to file. Most people find the 30% too high, so your second option is to elect for the IRS to treat that income as business income in the US. You will be obligated to file a US tax return, but now you get taxed on not your gross, but net rental proceeds. So you can deduct all your expenses, plus you get graduated tax rates.
- It sounds pretty involved. I mean, I guess the thought is just you should really just write down, or kind of talk with someone about all things you need to do. But I mean, is there anything-- what do I need to do just to ensure that I'm not paying more taxes than I need to when I do decide to buy US property?
- Right. So when you're deciding to buy, please talk to somebody before you actually make the purchase, and walk through the analysis.
- Chris, always a pleasure. Thank you.
- Thank you Kim.
[MUSIC PLAYING]
- Let's imagine there's Bob, a retiree, owns property in Palm Springs, California. Now, Bob's heard that probate in California's a bit messy-- not far from the truth. So he decides to do a probate maneuver. He puts his daughter on title as a joint owner of the property. It works for probate planning, not very different than what would be done in Canada. But from a tax point of view, it's a terrible move.
- Why?
- Well, first of all, US has a gift tax concept. So now the daughter's on title and she hasn't paid anything for the property, so Bob has made a gift to her. Top tax rate-- 40%. On the Canadian side, we actually have a disposition. It went from one owner, now to two owners. So we have capital gains tax in Canada, and to make it worse, Canada does not offer a credit for the gift tax paid. So he's looking at US gift tax, Canadian capital gains tax, and the daughter has actually acquired her interest in the property at her father's-- Bob's-- historical cost base. So in the future when she sells it, she's looking at US capital gains tax, or a triple whammy with a small planning error.
- Yeah. Small planning error-- very, very costly planning error. OK, and also for context, these are people who are looking to buy property with a longer term vision-- like, to have it stay in the family a little longer.
- That's exactly right. I mean, if you're looking to buy it to flip it, some different context.
- OK. So let's start with, again, long-term, looking to buy something. How do I avoid what just-- you told us about?
- To be very frank with you, it's difficult to avoid everything. But if you're proactive, you can certainly plan around many things. So in the cross-border context, it is a very complex puzzle, and it's important to have advisors who are familiar with the issues and can advise you appropriately based on your facts and circumstances. Let's take another example.
Historically, the most common issue facing Canadians purchasing US real estate has been US estate tax. And US estate tax is terrible, because A, it's a fair value tax so it doesn't correlate to any gains or losses. It's strictly a property transfer tax. The tax rate is very high at 40%. And it also applies at each death.
So if I own property when I die and pass away, there's potentially a 40% haircut then. If I bequeath the property to my spouse and she dies, there's another 40% haircut then. So it's a terrible tax. But guess what? In 2019, the exemption is a very generous 11.4 million US dollars-- so maybe about 15 million Canadian.
So are you really affected by this if your net worth is below that number? Of course not. Maybe you have to file, but you won't have to pay tax. But then again, if I say that, I can also tell you right now California has a bill on the table where they're looking to implement their own state-specific estate tax. So maybe it was an issue. It's no longer an issue today, but it might be, again, an issue for those people purchasing in California. And you can't expect every person to be on top of this. You would need advisors who can guide you appropriately.
- You're scaring me off doing this all together at this point. So that's the estate tax. What probate issues?
- Right, so probate, Kim, is really a validation of the will. And probate can be a challenge because of the delay and the cost involved. The delay, because if you have a Canadian will, it will be probated in Canada first, and only then submitted for probate in the foreign jurisdiction. Cost because you're looking at paying legal costs in Canada and, of course, legal fees in the US, and potentially court fees in the US. So I think you take a facts and circumstances approach and see if probate and the costs associated with it are an impediment.
If they are not, probate planning might not be your priority. If probate planning is a priority, you certainly can do something, but as long as you approach it with caution. So going back to our example with Bob and the daughter, that wasn't a very good example of probate planning.
If you wanted to, for instance, put your spouse on title, understand that there is a US $155,000 annual exclusion from gift tax. So potentially, probate planning is easier between spouses. Not so easy when we're looking at parents to children.
- OK, let's say that, then, I've talked to you or talked to somebody qualified. I figured the probate side of things. I'm under the threshold, so I'm fairly comfortable on that in terms of the future. Should I go ahead, then, and bid on a dream property? What's the next step?
- Life is way too short, so if that's your dream, you absolutely should, Kim. What I will say is this. First of all, before you plan to purchase, know who will own the property. Is it going to be you? Is it going to be your spouse? Or is it going to be somebody else? And know how you'll own the property.
How will you hold it as a title-- solely in your name, as a joint tenancy, as a tenancy in common? Are you using a trust structure? So answer that beforehand. It's sometimes too late to plan for it after the fact. And of course, understand that even if you're owning enough for the long-term, if you do choose to sell it a few years later, there'll be US capital gains tax. Of course, as a Canadian resident, you also report the gain in Canada.
We should have an offsetting foreign tax credit, so it shouldn't be double-taxed, but sometimes a foreign exchange does cause a bit of tax leakage. And finally, US will automatically impose a 15% withholding tax when you sell that property. So for the larger properties, there could be a cash flow issue.
- What if I want to make it more complicated-- I buy the property, and then, you know what? I'm not there all the time. I'd like to rent it out some of the time. What does that cause?
- Right. So if you are a landlord earning rental income in the US, most certainly you have to pay tax on that, right? So your easiest option is to do nothing, and the tenant is then obligated to withhold 30%, submit that to the IRS, and you're free and clear, no tax return to file. Most people find the 30% too high, so your second option is to elect for the IRS to treat that income as business income in the US. You will be obligated to file a US tax return, but now you get taxed on not your gross, but net rental proceeds. So you can deduct all your expenses, plus you get graduated tax rates.
- It sounds pretty involved. I mean, I guess the thought is just you should really just write down, or kind of talk with someone about all things you need to do. But I mean, is there anything-- what do I need to do just to ensure that I'm not paying more taxes than I need to when I do decide to buy US property?
- Right. So when you're deciding to buy, please talk to somebody before you actually make the purchase, and walk through the analysis.
- Chris, always a pleasure. Thank you.
- Thank you Kim.
[MUSIC PLAYING]
