Following are five misconceptions Canadians may have about buying US real estate, from Keats, Connelly and Associates’ partner and CEO, Dale Walters, a leading cross-border wealth expert.
1. If I report my rental (or capital gain) income in Canada, I will not have to report the income in the US. Conversely, if I report in the US, I will not have to report in Canada.
The basic tax concepts that determine taxability are residency/citizenship, and where the work or business activity took place. The business (rental) activity happened in the US, therefore the income is taxable in the US.
Likewise, as a resident of Canada, you are subject to tax on your worldwide income regardless of where it is earned.
You can use the foreign tax credit to reduce your Canadian tax by the amount of the US tax paid, if any.
2. Owning US real estate in my Canadian corporation is a good idea.
There are a number of reasons not to own US real estate in or through your Canadian corporation and for most people, there is no real advantage in doing so.
Any profits will be subject to double tax in the US. You will also lose the special tax treatment of long-term capital gains at the 15 percent rate. All income in a corporation will be taxed at ordinary income tax rates, which range from 15 to 38 percent. Foreign rental income cannot be deferred income in your Canadian corporation.
3. If I rent only to Canadians and they pay only in Canadian dollars, I will not owe US taxes.
This misconception is similar to the first one, but one that is asked quite often. Again, the basis for taxation is fundamentally two things: residency/citizenship and where the activity took place.
Where a tenant is from or what currency they pay you in is irrelevant to the taxability of the income. You must pay tax in the country the income is earned and in the country you live in. Do not forget to use the foreign tax credit to prevent double taxation.
4. Having a house in the US, at my death, will cause all of my assets to be subject to US estate tax.
The nonresident estate tax system is set up to tax only the assets in the US at the time of death. If you do not want to, you do not have to let IRS know about any of your other assets. However, it is usually beneficial to let the IRS know of your worldwide assets because of the exclusion from US estate tax allowed under the US-Canada Treaty.
The US-Canada Treaty allows Canadians to use a percentage of the exclusion Americans are allowed – currently $5,000,000 per person. The exclusion is based on a percentage of assets in the US, compared to your worldwide assets. For example, if that exclusion worked out to 10 percent, you would be allowed a $500,000 exclusion per person. There is one catch however: You have to report to the IRS your worldwide assets.
5. The US will impose a tax of 50 percent on assets subject to US estate tax.
The 50 percent tax is part exaggeration and part lacking information about the US-Canada treaty. Prior to 2010, the highest marginal tax rate was 45 percent; the rate is now a flat 35 percent for amounts over the exemption.
As mentioned above, the Treaty allows Canadians an exemption based on the percentage of US to worldwide assets. As long as your worldwide assets are less than $5,000,000 ($10,000,000) per couple, there will be no US estate tax.
For more information about buying real estate in the US, consider Walter’s book, Buying Real Estate in the US: The Concise Guide for Canadians, is available in our Web store.