Buying and Selling U.S. Property or a Property Abroad. Dean Smith

Buying and Selling U.S. Property or a Property Abroad Dean Smith

Issues Personal use or business (rental use)? Canadian issues Reporting of world wide income Foreign reporting issues U.S. issues Income tax considerations U.S. estate tax considerations U.S. gift tax considerations Probate considerations

Issues - Caveat This presentation assumes that at all times the investor/purchaser/taxpayer is a Canadian resident and is NOT a United States citizen or resident for U.S. tax purposes. If your client is a United States citizen or resident information contained in the presentation may not be fully applicable.

Canadian Tax Issues Personal use If held personally no income tax issues until sold Principal residence exemption may be an option Capital gain purchase price and selling price need to be converted into Canadian dollars at appropriate spot rate If held in Canadian corporation shareholder benefit issues (Single Purpose Corporations no longer applicable) No T1135 filing requirement

Canadian Tax Issues Business use Must report world wide income and expenses in Canadian dollars (usually done using the Bank of Canada annual average exchange rate) Tax depreciation (capital cost allowance) elective deduction Can not create or increase a loss by claiming CCA Foreign source income country where the property is located will usually have the first right to tax the income Foreign tax credit issues

Buying Other Foreign Property Beware of varying tax systems Different reporting requirements Examples: Spain: owning rental property as a non-resident of Spain while maintaining your residency in Canada, will be taxed on the rental incomes at a flat 25 per cent of the gross rents without any deductions. Portugal: taxation of the ongoing rental income is at a progressive rate on the net rental income.

Foreign Asset Reporting T1135 Form T1135, Foreign Income Verification Statement Foreign investment property (specified foreign property) costing $100,000+ is owned at any time in the year, T1135 must be filed Cumulative not property by property Filed by Canadian resident individuals, corporations and trusts, and also many partnerships

Buying U.S. Real Property Foreign Investment in Real Property Tax Act (FIRPTA) get to know U.S. acronyms! Issues arise During period of ownership On sale or exchange On gift On death

Buying U.S. Real Property These issues include Effect on residence status Income tax/withholding tax on rental income, actual and imputed Capital gains on sale or exchange of the property Basis computation issues (including depreciation) FIRPTA and state withholding Gift tax, estate tax and generation skipping tax (the U.S. transfer tax system)

FIRPTA FIRPTA withholding if owner is not a United States person 10% withholding imposed on gross amount realized at sale IRS is concerned about collecting taxes once the funds leave the U.S. $300,000 exemption where buyer will use property as principal residence Exemption protects buyer Exemption is only from withholding, not from FIRPTA taxation This is not a final tax but is a credit that is claimed on the seller s U.S. tax return Excess withholding can be avoided based on maximum tax See IRS Form 8288-B and Rev. Proc. 2000-35, 2000-2 CB 211 Some states require withholding on sale by non-residents Form 1040NR (if owned by individual) must be filed to report the sale/income due June 15 th following year

Some Translations A Translation from American to Canadian Title company quite often used instead of lawyer as in Canada Title Insurance usually purchased Documentary Stamp Tax (instead of Land Transfer Tax) usually on seller. (Can Be Changed Through Contract) Can close on property in Canada Home Owners Association = Condo Association. Estoppel Letter Will Be Needed To Close Should hire a Certified U.S. real estate lawyer (who knows your Canadian) Make sure they understand that you are not a U.S. person Don t confuse your Canadian Social Insurance Number (9 digit number) with a U.S. Social Security Number or ITIN (also a 9 digit number)

U.S. Estate Tax The U.S. imposes an estate tax on wealthy taxpayers Canada does not have an Estate Tax but has a deemed disposition on death capital gain, including on the taxpayer s last return Under the Internal Revenue Code a non-us citizen, nondomiciliary only has US $60,000 of value before they are subject to US estate tax

US Estate Tax Applied at death For U.S. persons apply - to world wide estate For non-domiciled (nonresident) non-u.s. citizens apply to U.S. situs assets only (some exceptions) In law, the situs (pronounced "sī'təs") (Latin for position or site) of property is where the property is treated as being located for legal purposes

U.S. Situs Assets Real property located in the United States Tangible property located in the United States Stocks issued by U.S. domestic corporations Debts obligations of U.S. persons (though there are exceptions) RRSP look through (an RRSP is considered a foreign grantor trust for US tax purposes)

Non-U.S. Situs Assets Proceeds of Life Insurance Bank Deposits and Certain Other Debt Obligations Works of Art on Loan for Exhibition Stock in a US Regulated Investment company (RIC)

Unified Credits Applicable Exemption Amount (2015) is US $5,430,000 Applicable Credit Amount (2015) is US $2,117,800 Amounts indexed for inflation Under Article XXIX-B of the Canada-United States Tax Convention (1980), Canadian residents have access to the annual credit on a pro-rata basis US situs assets / world wide assets x Applicable credit

How does it all work? 1) Determine gross estate subject to taxation (FMV of U.S. situs assets) 2) Deduct any allowable deductions to arrive at taxable estate (prorate global deductions) 3) Apply U.S. transfer tax rates to taxable estate 4) Apply any applicable credits

An example Canadian resident not a U.S. person Single person - divorced Bought Arizona vacation property for $750,000 Current fair market value - $1.2 million Has $750,000 of US stock in his portfolio Current net worth - $10 million Funeral costs were $25,000

An example US situs assets = $1,950,000 Allocated funeral expenses = $4,875 ($1,950,000 / $10,000,000 x $25,000) Taxable Estate = $1,945,125 ($1,950,000 - $4,875) Estate Tax (pre-credit) = $723,850 Unified Credit = $412,971 ($1,950,000 / $10,000,000 x $2,177,800) Estate Tax (after Unified Credit) = $310,879

U.S. Estate Tax If net worth < US $5,430,000 you do NOT have a U.S. estate tax exposure You do, however, have a filing obligation if the fair market value at death, of U.S. situs assets, exceeds US $60,000. You can double up unified credit (under Treaty) is property left to a surviving spouse Must file as you are relying on a treaty override to eliminate U.S. estate tax.

Strategies to Purchase U.S. Property For Canadians

Goals Want to take advantage of long term capital gains rate 15% or 20% (depending on level of U.S. taxable income) Corporations are not entitled to long term capital gains rate ordinary income up to 35% Some states (Florida, Texas) do not impose a state personal income tax but may impose a corporate tax (Florida 5.5%) Liability issues

Options Individual (personal) ownership Corporate ownership U.S. corporation (USCO) Canadian corporation (CanCO) Partnership Limited Liability Corporations Trusts

Individual Ownership Positives Keep Low Individual Tax Rate (Up to 20% maximum rate for Long-term capital gains) Step Up In Basis On Death Variety of Options Doubling of Exemption Will Planning Non Recourse Mortgage Term Life Insurance Cost Effective Issues To Think About Ensure no estate tax Probate No probate if held in joint tenancy Code Section 2040(a): Ensure that payment of property can be traced back Can Be Long Process 12 months. Local counsel may be needed FIRPTA

Individual Ownership Income Tax Issues Individual ownership Need to file U.S. personal tax return Form 1040NR (if rented) Income / expenses also included on Canadian return U.S. taxes paid eligible for FTC in Canada Capital gains treatment on eventual sale Long term if property held greater than 1 year No liability protection need sufficient insurance

Individual Ownership Title Canadian Spousal Joint Name Not effective for estate tax planning purposes, but simplifies transfer at death. U.S. situs asset for U.S. estate tax purposes Tenants in common ownership preferred versus joint tenancy Joint tenancy deemed disposition on death of first spouse unless otherwise demonstrated survivor funded purchase Tenants in common possible benefit from favourable valuation of minority interest (FMV decreased how can you sell 40% of property?) May be appropriate for smaller estates Possible gift at time of purchase Prorated use of unified credit Canada/U.S. treaty relief

Corporate Ownership (USCO) Positives Commercial anonymity No probate No Gift Tax On Intangible Property FIRPTA No tax returns due by individuals prior to (and possibly even upon) sale event Issues To Think About U.S. Estate Tax High Tax Rate (Up to 40%) on capital gain Operating Cost On death, step up of shares but not of underlying property Risk of imputed income

US CO Issues To Think About 50% or greater shareholder must be disclosed on Form 1120 loss of anonymity 25% or greater shareholder must be identified on Form 5472 if U.S. corporation engages in related party transactions $10,000 late filing penalties Reporting extends to foreign corporation engaged in U.S. trade or business

Corporate Ownership (CanCo) Positives No U.S. Estate Tax No probate No Gift Tax On Intangible Property Things To Think About FIRPTA Shareholder Benefit Rule High Tax Rate (Up to 40%) on capital gain Operating Cost On death, step up of shares but not of underlying property FIRPTA Potential Branch Profits Tax or dividend withholding Tax

CanCo Ownership - Further Details If a foreign corporation Is rent effectively connected? Is shareholder tenant a withholding agent? Trade-off of depreciation vs. potential increase of FIRPTA gain Branch profits tax

CanCo Further Details If rented must file Form 1120-F to report income and expenses Long term capital gain treatment not available May also be subject to state corporate tax U.S. taxes paid can be claimed as a foreign tax credit in Canada

CanCo Ownership - Further Details Issues on Sale or Exchange by a Foreign Corporation Mandatory gain recognition and taxation (Section 897) 20% tax rate for capital gains of NRAs, 25% for recapture income 34%/35% tax rate for corporations on net income after reduction for net operating loss carryovers Branch profits tax on gain if property is owned by foreign corporation and steps are not taken to completely terminate U.S. business Credit allowed for tax withheld under Section 1445 Basis If home used in trade or business, may require depreciation adjustment

CanCo Ownership - Further Details Issues on Sale or Exchange by a Foreign Corporation (cont d) Availability of net operating loss carryovers Regs. 1.873-1 and 1.882-4(a) deny losses and deductions if no tax returns filed during ownership period but basis may still be reduced by allowable depreciation Sale of principal residence exclusion Section 121 Technically can apply to NRAs But facts will often make section unavailable except for departing individuals Section 1031 unavailable for personal use property Section 1031 inapplicable to exchange for foreign real property

CanCo Ownership - Further Details Issues on Sale or Exchange (cont d) Branch level taxes if owner is foreign corporation Branch profits tax of 30% on effectively connected earnings, without reduction for net operating loss carryovers Opportunity to reduce branch profits tax through termination of trade or business Note that if the corporation sells a home and buys another: The reinvestment may qualify if the property is used in a U.S. trade or business and the purchase increases the U.S. net equity The alternative, using the termination of the trade or business rule, may work if the three-year non-reinvestment rule is followed and the three-year extension of statute of limitations (even if the new home is purchased through a different foreign corporation) is elected

Canadian Partnership Positives Keep Individual Tax Rates As Partners Pay Tax Possibly No U.S. Probate No Gift Tax On Intangible Property Issues To Think About Operating Cost of Both GP and LP Gray Area: Two Tier LP IRS position: Partnership interest has U.S. situs if partnership engaged in U.S. trade or business If NRA contributes property to partnership but retains right to live in property, Section 2036 may apply: Estate of Lorraine C. Disbrow v. Commr., TC Memo 2006-34 FIRPTA

Canadian Partnership Income Tax Foreign or domestic Where relevant, distinction based on place of organization Either way, one level of tax and long-term capital gains rates available to individual partners Section 1446 will apply either way if partnership has ECI Payments (rent, sale proceeds) to foreign partnership subject to withholding by payor (tenant, buyer) under Sections 1441 and 1445 Use of home may require income to be imputed Section 707(a); see Dolese v. Comm r., 811 F. 2d 543 (10 th Cir. 1987) Transfer to partnership entitled to non-recognition, but notice to IRS needed to avoid FIRPTA withholding Gift Tax Gift of intangible by NRA generally not subject to gift tax No difference between foreign and domestic partnership

Canadian Partnership Estate Tax Situs is the critical factor Rules for partnership interests unclear IRS position: Partnership interest has U.S. situs if partnership engaged in U.S. trade or business Apparently irrespective of relative sizes of U.S. business and other activities and assets What if partnership is not actually engaged in trade or business but has income deemed effectively connected under Section 897(a) or NRA made net rental income election under Section 871(d)? Other possibilities: Situs based on residence of partner (mobilia sequuntur personam) Place of organization Look-through (partnership as aggregate)

Canadian Partnership Estate Tax Situs is the critical factor Rules for partnership interests unclear IRS position: Partnership interest has U.S. situs if partnership engaged in U.S. trade or business Apparently irrespective of relative sizes of U.S. business and other activities and assets What if partnership is not actually engaged in trade or business but has income deemed effectively connected under Section 897(a) or NRA made net rental income election under Section 871(d)? Other possibilities: Situs based on residence of partner (mobilia sequuntur personam) Place of organization Look-through (partnership as aggregate)

Limited Liability Corporation Positives Individual Tax Rate No FIRPTA No probate Issues To Think About Double Taxation! - No Foreign Tax Credit

Limited Liability Corporation Positives No probate Typically revocable - Can Be Changed At Any Time Before Death Issues To Think About U.S. Estate Tax Other Cost Effective Options Available (life insurance etc.)

Canadian Trust Positives No U.S. Estate Tax Individual Tax Rates No probate Issues To Think About Ascertainable Standard Grantor trust issues 21 Year Rule If Trustee Spouse passes away first, settlor must pay rent. Alfred I. dupont Testamentary Trust v. Commr., 66 T.C. 1976, affd. 574 F.2d 1332 (5th Cir. 1978) FIRPTA

Property Already Owned - Sale to Trust? Unresolved matter. If promissory note exists, there must be evidence that the lendee is willing to pay it back, otherwise it may be subject to U.S. transfer tax (i.e. a gift) See: Davies v. Commissioner, 40 T.C. 525 (1963), acq. in result 1966-2 C.B.4 (1966). More Conservative Solution: Obtain a Non Recourse Mortgage/Life Insurance if property already owned rather than sell to a trust

Gifting? Issues at Time of Gift of U.S. Real Property Interest Gift tax applies to gifts of real property located in the United States, but not to gifts of stock in USRPHC or in partnership Gifts by Canadian Citizen/Resident of intangible property are not subject to gift tax Section 2501(a)(2) No marital deduction for gift to noncitizen spouse (example, from one Canadian to another) Section 2523(i)(1) Annual exclusion for gift to noncitizen spouse is increased to $100,000 Section 2523(i)(2). Indexed for inflation (2015 - $147,000). Annual exclusion for gift to non resident non citizen is $14,000 No Foreign Tax Credit available in Canada for any gift tax paid.

Ownership Issue Rental If rented: If no election made, gross rented taxed at 30% No return required to be filed Can elect to be taxed on a net income basis Tax depreciation is mandatory Return must be filed Consider state filings as well Can claim operating expenses Mortgage interest, property tax, insurance, etc.

Other Practical Issues Setting up entities Opening bank accounts this has become a real challenge Obtaining ITINs (miserably difficult) and EINs (relatively easy) Managing the property Basis Privacy Filing tax returns Recordkeeping Local transfer taxes on tax-free transfers Respecting structure U.S. Dept. of Commerce and Department of Agriculture reporting may apply Home country taxation

Probate Issues Two main problems: ties up property, can be expensive Also privacy concerns or may want to leave asset to spouse or certain beneficiaries Proper planning can avoid probate issues but rules vary from state to state

Probate Issues Some options to consider when planning (availability differs by state): Creating a will: does not require or avoid probate, but instructs on how to distribute assets Titling property so it transfers automatically Joint tenancy / tenancy by the entirety/community property with right of survivorship Setting up a living trust/alter ego/joint partners trust Make lifetime gifts Life estate deed Lady bird deed Transfer of property by affidavit Beneficiary deed

Thank You

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