Every winter, hundreds of thousands of Canadian snowbirds migrate to the southern United States in search of warmer weather.
Many of these snowbirds already own a vacation home in the U.S. and many more continue to buy U.S. real estate, even with the weaker Canadian dollar.
Regardless of whether you already own real estate in the U.S. or are thinking about purchasing U.S. real estate in the future, it’s essential to be aware of important tax implications and structure your affairs accordingly.
Navigating the U.S. tax system is not an easy feat, and owning U.S. real estate can expose Canadians to U.S. estate tax and probate fees, as well as U.S. income tax if the property is used as a rental property.
To help you understand the issues, here’s an overview of the tax implications Canadians may face when owning U.S. real estate and what you should consider to minimize your tax bill and avoid headaches.
Ongoing Tax Obligations While Owning U.S. Property
If your U.S. property is purely for personal use, then you do not need to file any U.S. income tax return. Other than the local property tax, no tax is payable on the account of you owning a U.S. real property.
However, if you rent out your U.S. property, there will be U.S. income tax obligations. You’ll need to report your rental income using one of two methods:
- You can have 30% of the gross rental income withheld by the tenant and remitted to the IRS, or
- You can elect to be taxed on the net rental income.
The advantages of the first method are that it is quite straightforward and no U.S. tax return needs to be filed. Having said that, most Canadians find the latter method to be more tax-effective, as you can deduct property taxes, mortgage interest and other expenses from the gross rental income. If you only rent out your U.S. property for part of the year, then you’ll have to prorate the expenses based on the number of days you rent out the property.
Regardless of the method you choose to satisfy your U.S. tax obligation on the rental income, you’ll also need to report the same rental income on your Canadian tax return if you are a Canadian resident (NOTE - you’ll be able to reduce Canadian tax on the rental income by claiming a foreign tax credit for the U.S. taxes paid, but you still need to include it in your Canadian tax return).
Disposition of U.S. Property
If you dispose of your U.S. property, you will be subject to U.S. income tax on the gain.
In order to make sure that U.S. tax is collected from non-U.S. Persons, the IRS imposes a withholding tax of 10% or 15% on the gross selling price. Often, the amount of actual income tax due is much less than the withholding tax required. In that case, you can apply for a withholding certificate from the IRS requesting a reduced withholding based on the expected U.S. tax on the gain. You’ll need to apply well in advance as it could take the IRS three months or more to issue such certificate. You’ll also need to apply for a U.S. tax identification number.
If you opt not to apply for a withholding certificate, you can file a U.S. personal income tax return and request a refund, which also may not be a speedy process.
As with rental income, you’ll also need to report the sale and pay tax on the net gain in Canada, which can be reduced by claiming a foreign tax credit of U.S. taxes paid on the same income.
U.S. Estate Tax
What happens if you die while owning U.S. real estate?
In Canada, a person is deemed to have disposed of all of his or her capital property at fair market value at the time of his or her death (except for property transferred to a spouse or a trust for a spouse), triggering capital gains tax.
In the U.S., there is no such deemed disposition, but rather a deceased person is subject to an estate tax on the fair market value of his or her estate. U.S. citizens and U.S. residents are subject to U.S. estate tax if the fair market value of their worldwide assets at the time of their death exceeds the U.S. estate tax exemption amount.
Canadian snowbirds may be surprised to learn that they too may be subject to U.S. estate tax, even if they take painstaking measures to avoid becoming a U.S. tax resident.
U.S. estate tax applies to Canadians who are not U.S. citizens and have not become U.S. residents if they own "U.S. property" at the time of their death. Generally, U.S. property is considered to be any asset located within the U.S. for legal purposes, which of course includes U.S. real estate, but also includes other assets like U.S. stocks, investments and shares in U.S. companies This means that Canadians are subject to U.S. estate tax of up to 40% of the value of their U.S. property, including any real estate they own in the U.S.
However, the U.S.-Canada Income Tax Treaty provides some relief. Generally, if the total value of the deceased Canadian’s worldwide assets is less than the U.S. estate tax exemption amount in effect for the year of death, then there will be no U.S. estate tax due.
Even if you are able to take advantage of the Treaty and do not owe any U.S. estate tax, your executor must file a U.S. estate tax return if the total value of your U.S. property exceeds $60,000 USD. Without filing the estate tax return and getting the appropriate certificate from the IRS, your executor may run into difficulties transferring the title of your U.S. real estate after your death.
There is one more wrinkle to the U.S. estate tax regime to consider. For the purpose of U.S. estate tax, a “U.S. resident” is defined as an individual who is “domiciled” in the United States. Domiciled is difficult to define as it depends on a person’s intent. One could be considered to be domiciled in the U.S. without being a resident there.
There are strategies that can minimize and sometimes completely eliminate your U.S. estate tax exposure, but the right strategy will depend on your personal circumstances and preferences, so you should consult with a tax professional.
Probate is a court-supervised process of identifying the assets owned by a deceased person in his or her sole name at death and distributing them to his or her beneficiaries.
Probate fees and procedures vary by state and sometimes by county. Moreover, some states require that you hire an attorney.
For example, if you own a condo in Florida, then you would be subject to the Florida probate process. In order to effectively transfer your Florida condo, your Will must be admitted to probate in Florida. If you died without a Will, probate is still necessary so your assets can pass to your heirs.
Probate can only be avoided if the property was not held in your name alone. For larger U.S. real estate, it may be worthwhile exploring different ownership structure options to minimize probate fees.
The Bottom Line
There are various methods available to Canadians to hold U.S. real estate, including using a trust, a limited partnership, a corporation or a combination of entities. In certain cases, direct ownership may be the most practical.
The ownership structure you choose can have serious implications for the taxes and fees you will be subject to if you pass away or dispose of the property while you’re still alive. It can also affect the ease with which you can transfer your U.S. real estate to another person, such as your spouse, a child or a third-party purchaser.
Ultimately, the ideal ownership structure for you will depend on your current and long-term plan for the property and your overall financial landscape.