Southern (tax) exposure

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1 Page 1 of 5 Winnipeg Free Press - ONLINE EDITION Southern (tax) exposure Estate levy menaces snowbirds By: Joel Schlesinger Posted: 6/11/ :56 AM Comments: 0 BUYING that snowbird nest in the warmer climes of the United States has likely never been more affordable. The Canadian dollar hovers near parity with the greenback. Borrowing money is cheap and expected to remain that way for the near future. But the biggest reason is many of the most desirable winter hot spots in the States are also those hardesthit after the real estate bubble burst more than two years ago. Other tax concerns If you plan to hold onto your U.S. property and pass it on to the family, the potential for estate taxes is the main concern, says accountant Christa Walkden. But individuals do have to be careful about how much time they spend in the States in any given year. If you visit the United States for more than 182 days in a year, you will have to file a U.S. tax return. This is based on the IRS's Substantial Presence Test, and the maximum number of days spent in the U.S. also must include time spent in the U.S. during the two years prior to the current year. One-third of the days spent in the U.S. from the previous year and one-sixth of the days spent in the U.S. two years ago make up part of the 182-day maximum. For those wintering every year in the U.S., the yearly threshold is 122 days. Canadians over the threshold, however, can file a Form 8840 with the IRS to avoid filing in the U.S. Taxes when selling When selling a U.S. property, capital gains on that property are taxed. The gains tax in the U.S. is presently 15 per cent, excluding any state capital gains taxes. The rate will increase to 20 per cent in Taxes on rental properties Because most Canadian owners don't live at their U.S. residence year-round, they often rent out the property. You do not have to file a U.S. tax return in that case, but the tenant is required to collect a 30 per cent withholding tax of the gross rent for the IRS. You then have to file a tax return to get a portion of the withholding tax returned, or you can make an election to have the rental property taxed on a net basis, eliminating the withholding tax and allowing for deductions such as maintenance, management

2 Page 2 of 5 fees and depreciation. Any taxes paid in the U.S. on rental income will offset Canadian income taxes on that same U.S. rental income. The 30 per cent withholding tax does not count as credit in Canada, meaning it's best to file a U.S. return. -- Meyers Norris Penny The following are the top personal marginal income tax rates for 2010 for the following southern destination states, and these would apply on any gain on sale or rental income earned within that state: Nevada -- No tax Florida -- No tax Texas -- No tax California per cent Arizona per cent North Carolina per cent South Carolina -- 7 per cent New Mexico per cent Hawaii per cent Need further explanation of how the estate tax works? Here's another example: The formula: (U.S. situ assets divided by worldwide assets) x $1 million exemption = tax sheltered U.S. amount The example: U.S. property: $300,000 Worldwide assets: $1.2 million ($300,000 divided by $1.2 million) x $1 million = $250,000 of the property is taxsheltered Estate tax rate on $50,000 that is not sheltered would be 37 per cent, amounting to $18,500 in taxes owing. Are U.S. equity mutual funds and exchange traded funds subject to U.S. taxes? All mutual funds and ETFs purchased on Canadian exchanges would be excluded from U.S. estate taxes, but ETFs and stocks purchased on U.S. exchanges would be subject to tax. Estate tax sheltering strategies There are a few ways to reduce the impact of the taxman if estate taxes again become a reality in 2011, including holding the asset in a trust and using a non-recourse mortgage. Lawyer Caroline Kiva says other strategies like joint tenancy, tenancy in common or having the property owned by a corporation often have more pitfalls than benefits, and it's important to seek advice to strategize properly.

3 Page 3 of 5 Prices for properties today are a fraction of what they were in 2006 and In Palm Springs, for instance, even luxury condos and homes are selling for 50 per cent of what they once did, says Paul Kaplan, a California realtor whose business now consists of 60 to 70 per cent foreign buyers, the majority of whom hail from Alberta and B.C. "Homes that I'm selling now for about $300,000 to $350, three-bedroom homes with a pool -- in 2006 to 2007, they could have sold for around $700,000," he says. But all that sparkles in the Golden State -- or anywhere else -- doesn't mean there aren't financial tarnishes that shouldn't be overlooked. Likely the thorniest issue is taxation, which can present complex financial planning problems that are no easy feat to solve. And leading the way into the confusing maze of taxation are the issues surrounding estate taxation. Death and taxes go hand in hand in this particular case. But if you own U.S. property and are 'lucky' enough to die before the end of the year, you don't need to worry about estate taxes because for 2010, there is no estate tax. The federal law in the U.S. to phase out estate taxes, enacted in 2001, expired at the end of But unless the U.S. passes another law regarding estate taxes before the end of this year, estate taxation reverts back to pre-2001 levels. As a certified public accountant specializing in U.S. taxation, Winnipeg-based Christa Walkden says she has been advising most clients to take a worst-case taxation scenario perspective -- that is the rules would revert back to Before 2001, U.S.-based assets -- real estate and other assets -- received a $1-million tax exemption for the estate. In 2009, the final year of the estate tax cuts, the exempt amount was a Bush and buddiesfriendly $3.5 million. For foreign owners of U.S. property and investments, such as stock in U.S. companies, the rules included owners' worldwide assets as part of the taxation formula to determine how much of the U.S.-situated investments would be tax-sheltered upon death. "Under the treaty between Canada and the U.S., Canadians are entitled to a pro rata portion of what Americans are eligible for," says Walkden, an accountant with Meyers Norris Penny. It's basically a fractional amount -- the U.S. asset as the numerator (top part) and the worldwide assets at the denominator (bottom part) -- that is multiplied by the exemption amount to determine how much of the U.S. asset will be tax-sheltered. "If we assume that laws are going to sunset back to the 2001 level in 2011, we will be dealing with a $1- million exemption." For Canadians, who don't own more than $1 million in worldwide assets or who own a U.S. investment of a small sum, they likely have little to worry about, she says. In fact, U.S. assets of $60,000 or less are exempt regardless of the owner's worldwide assets -- at least under the old rules.

4 Page 4 of 5 Yet even properties worth a few hundred thousand dollars would avoid estate taxes so long as total worldwide assets remain $1 million or less. "So if we take that ratio of $150,000 over $1 million and we multiply it by $1 million, we end up getting 100 per cent of that $150,000 sheltered from that estate tax by the special pro rata credit that a Canadian would be entitled to," she says. But the more worldwide assets owned by an individual, the less U.S. assets are sheltered from estate taxes. For example, a condo located in Phoenix may be only worth $150,000, but the owner's worldwide assets are $10 million. "So then we have $150,000 over $10 million multiplied by a million, so now we're sheltering only a small portion per cent," she says. "Now we have a $150,000 property and you only get to exclude $15,000 of that from estate tax." I N Canada, that same asset would also be subject to taxation upon death, but only the capital gain on the property is taxed, and at a more favourable rate. The highest capital gains tax rate in Canada works out to be about 23 per cent, whereas the U.S. estate tax could be as high as 55 per cent. The property, however, cannot be taxed twice. Under the Canada-U.S. tax treaty, the estate has to pay the higher U.S. estate tax rate on the U.S. property, and in return it receives full credit with Canada Revenue Agency. Of course, if the estate's assets will be worth less than $1 million, all this complexity becomes a moot point. But many Canadians underestimate the worth of their estate -- at least when seen from the perspective of the IRS, says Caroline Kiva, a lawyer with Winnipeg-based Pitblado LLP. "If you have a life insurance policy, that death benefit value also comes into play," she says. "People think that they have a house worth $200,000 and investments worth $300,000, and that they only have only $500,000 in assets, but then there's a million-dollar policy that may come into play in the estate tax calculation." Canadians are often advised to use life insurance as a tax-free source of money to cover Canadian income tax on their estate, but this benefit is counted as part of the worldwide assets in the U.S. estate tax calculation. And it could easily push assets above the $1-million exemption mark, exposing a portion of the U.S. property to taxation. Still, Canadians whose estates may face U.S. estate tax exposure do have means at their disposal to lessen the impact of the taxes, but Kiva says it's a good idea for them to seek advice from a lawyer or accountant to avoid picking a strategy that won't work. "A lot of times people will tend to focus on the Canadian rules of probate avoidance, so they'll hold their

5 Page 5 of 5 assets in joint name," she says about one possibly misguided strategy. But unless both tenants contribute payments for ownership, the IRS will consider the U.S. asset as wholly owned by the tenant who paid for the property. Others try putting their children's names on the deed, but this could make the property subject to a U.S. gift tax, which does not receive a tax credit in Canada, meaning the property could be taxed in the United States and Canada. Yet despite the complications, Kiva says people shouldn't let the estate tax question "frighten" them away from purchasing property. "It's just a question of doing your homework in advance and being aware that there might be exposure to U.S. estate tax, but it still may be worth it because you get to enjoy property while you're breathing." giganticsmile@gmail.com Check the box to include the list of links referenced in the article.