U.S. real estate continues to draw snowbirds looking for good deals
A strong loonie and the soft U.S. housing market continues to inspire Canadians to shop for vacation or rental property south of the border.
“People are still finding good deals and buying U.S. real estate,” says Tannis Dawson, senior specialist of tax and estate planning at Investors Group in Winnipeg.
But there are a number of considerations to keep in mind before jumping at the chance to own a vacation home in the U.S. sunbelt. “Financing has tightened up,” says Frank Di Pietro, director of tax and estate planning at Mackenzie Financial Corp. in Toronto. “Most American banks won’t provide mortgages to foreigners unless they have established a U.S. credit history.”
However, existing clients of Canadian banks that have U.S. subsidiaries will be able to obtain U.S. mortgages. “We’ll refer the client to an advisor who specializes in mortgages at Harris Bank in the U.S.,” says Judith Chambers, BMO Harris Private Banking’s Winnipeg-based vice president and market manager for the Manitoba region. Harris Bank is the U.S. arm of BMO Financial Group.
But most Canadians go shopping for U.S. real estate with cash, Dawson notes. “Paying cash or using Canadian debt to finance a U.S. property can make more sense than taking on U.S. debt. You need to consider where the loonie could go before taking out a U.S. mortgage.”
Canadians also need to consider how they will hold the U.S. property. A common estate planning strategy in Canada to avoid probate tax is to structure ownership of the property as joint tenants, which includes the right of survivorship. This means each spouse has an undivided, one-half interest in the property. Upon the death of the first spouse, the interest of the deceased passes directly to the survivor without incurring taxes.
But Di Pietro notes this strategy can result in double taxation in the U.S. “Canadians may assume, because the U.S. property is in two names, that only half its value will fall into the estate for tax purposes. But, unless it can be proven that both spouses each contributed their own funds to buy the property — and that may be difficult to do, especially if the property was purchased years ago — the IRS will assume it was owned by the first to die. And when the second spouse dies, the property will be taxed again as part of her estate.”
A better strategy, he says, is to hold the property as joint tenants in common. “Then, when the first spouse dies, only 50% of the value of the U.S. property will be included in his estate for tax purposes.”
Families of Canadians who own U.S. real estate may be in for a tax hit when they inherit the property. While Canadian tax law imposes a tax only on the appreciation of the value of assets held at death, U.S. estate tax is based on the fair market value of all U.S. assets on the date of death. So a Canadian who plans to buy a home in the U.S. will need to review his financial and estate plans, and those of his spouse, and determine the worldwide assets of each and the percentage of these that are in U.S. assets.
Under legislation passed by the U.S. Senate on New Year’s Eve and approved by the House of Representatives on Jan. 1, Canadians who hold U.S. assets and whose worldwide estates — including their Canadian homes, automobiles and investments — are worth less than US$5.12-million will be exempt from U.S. estate tax upon their deaths; this exemption amount will be indexed for inflation going forward. Estates that are worth more than US$5.12-million are now taxed at 40%, up from 35% last year.
The 11th-hour deal averted an automatic return to the US$1-million per person exemption this year—the exemption amount for 2001 — and a 55% tax rate on estates worth more than this.
It’s not only vacation homes that are subject to U.S. estate tax. It can also take a big bite out of an estate if a Canadian dies owning U.S. corporations and U.S. business assets, Di Pietro adds.
If a Canadian sells the U.S. property in his lifetime, the sale would trigger U.S. capital gains tax, Dawson notes. “And 100% of the capital gain is taxable, unlike the 50% in Canada. However if you owned the U.S. property longer than 12 months, you would be taxed at a lower rate: 15% in 2012 vs. your personal marginal U.S. tax rate if you held it under 12 months.”
The capital gain would also need to be claimed on the Canadian tax return, but a foreign tax credit can be claimed on the U.S. tax that was paid on the gain.
Canadians who rent out their U.S. property will have to pay a 30%
withholding tax on the gross rental income, Dawson says, but maintenance
expenses can be deducted. They will also need to file U.S. income tax
returns and include the income on their Canadian tax returns. However,
the Canada-U.S. Treaty provides a credit to avoid double taxation.
Some states, Dawson adds, levy state taxes on rental income.
Length of stay
Canadians are considered resident aliens in the U.S. if they pass the “substantial presence” test, a complex formula that looks at how much time a Canadian spends in the U.S. over a three-year period.
“In general, if you spend on average more than four months a year in the U.S., you’ll be considered resident aliens and have a legal obligation to file a tax return in the U.S.,” Dawson says. However, Canadian snowbirds who file IRS Form 8840, the Closer Connection Exception Statement for Aliens, establishing that they have a closer connection to Canada, won’t need to file a U.S. return.
“But that’s only half of the equation,” says Michael Mackenzie, Toronto-based executive director of the Canadian Snowbird Association. “U.S. immigration does not want Canadians in the U.S. for more than six months in any 12-month period. If you fly down to your U.S. vacation spot, the American government knows when you arrive and when you leave. We’re not sure how up-to-speed they are about snowbirds who travel by car, but we recommend you carry a folder with documents showing that you have a stronger presence in Canada and will therefore return to Canada: copies of deeds to homes in Canada, bank accounts, bills, etc. And a no-brainer is a return plane ticket, although some people insist on buying one-way tickets, thinking they can purchase cheaper flights home in the U.S.
“But some snowbirds enjoy themselves so much,” he says, “that they decide to spend an extra month in the U.S. They may get away with it that year but it will generate an exit flag. And when they return the following year, they could be told to come back in two or three months, or they could find themselves banned for five years. More and more people are being banned and the fact that they own a home in the U.S. will make no difference.”
Di Pietro says snowbirds should factor in legal fees and closing costs when purchasing a U.S. property. Property taxes will also be levied. And the property will need to be insured against theft and natural disasters, such as hurricanes and floods in Florida. “The cost of property insurance in some states can be two to three times what it is in Canada,” he says.
SOURCE:For Postmedia News