Tax planning essential for Canadian owners of U.S. property

By Staff

For Canadians who own real property in the United States, staying proactive, complying with U.S. tax rules and regulations and staying on top of pre- and post-sale planning are essential to ensure they don’t lose money on an otherwise potentially profitable investment, says Oakville-based U.S. tax attorney (NY, DC) Alexey Manasuev.

As Manasuev, principal of U.S. Tax IQ, tells, the first question Canadian buyers need to answer is why they are purchasing the property — which will help inform how they structure it for tax purposes.

“Before doing anything, they have to figure out their game plan. Why do they want to buy that property? Do they want it to stay in the family, or do they plan on holding it for a short period of time, selling the property and buying another with the gains received on the investment and continuing to grow the investment in that fashion? Or they may want to use the property for their vacation or personal use for part of the year, and for the remaining time of the year, they may want to rent it out for income,” he says.

For example, he says, for those who plan to use a U.S. real estate for personal purposes, a corporate structure for holding the investment is likely not a good fit.

“If you put the property in a corporation or even in a trust, that may well protect you from estate tax liability in the future, but that would present several issues with your ongoing compliance — including related costs as well as potential complications,” says Manasuev.

“If you put your property into the corporation, you have to explain the reason why you’re doing this, because the corporate solution must have a business purpose,” he adds.

Those who put their property — a house or apartment, for example — into a corporation are required to list the corporation as the owner on title and pay rent to it, says Manasuev. They are also required to file U.S. tax returns on behalf of the corporation.

“If you have any entity in the picture, such as a corporation or a partnership, those entities would be required to file returns even though you are technically using the property for your personal use. The reason why they would be required to do so, even if you don’t have income, is because that’s the law and technically the corporation is renting the property to you, and the corporation is required then to pay taxes on that rent.”

However, Manasuev says, many people who choose this structure fail to file tax returns, which means they are not complying with the applicable U.S. tax rules.

“This always comes up either at the time of the sale or when the person passes away. They then have to do something to make sure they are compliant. They have to do it quickly, and they have to pay a lot of money,” he says.

At the same time, those who choose to rent out their property and hold it individually are also required to file tax returns, says Manasuev.

“You would be better off if you claim the net rental income election, which would allow you to not be subject to 30 per cent withholding tax on a gross basis, but rather, to pay tax on a net basis by having the ability to deduct any relevant expenses and take any deductions that are related to your investment and your rental property,” he suggests.

On the other hand, those who own U.S. real property individually and do not rent it out or make any income from it are generally not required to file tax returns, says Manasuev.

At the same time, he says it is a good idea for all property owners to keep receipts, including the original closing documents.

“As a Canadian, you also want to make sure when you purchase your U.S. real property, that you get a confirmation or some sort of affidavit from the person that you’re buying it from that they are a U.S. person so that you are not required to deal with Foreign Investment in Real Property Tax Act (FIRPTA) withholding requirement complications in the future if no FIRPTA withholding was done, or if FIRPTA withholding was required, but the amounts were underwithheld. Ultimately the buyer is considered to be the withholding agent for FIRPTA purposes and they are primarily liable for any unpaid or underpaid taxes,” says Manasuev.

When it comes time for a Canadian to sell a U.S. property that has been rented out, under FIRPTA withholding requirements, the escrow company is required to withhold 15 per cent of gross sales proceeds, subject to certain exceptions, which is often significantly higher than the seller’s actual tax liability.

“They would remit it to the IRS, and then the seller would file a U.S. tax return to claim a refund that is the difference between the seller’s ultimate tax liability and the amount withheld under FIRPTA rules,” says Manasuev.

In some cases, says Manasuev, a seller has to wait a year or two before they see their refund. However, to avoid this situation, the IRS does allow sellers to fill out an application for a withholding certificate on or before the closing date. The IRS generally approves the withholding certificate within 90 days. The escrow company holds the required 15 per cent in escrow until the IRS makes its determination. Once the withholding certificate is received, the escrow company remits the amount required under the withholding certificate to the IRS and returns the overwithheld amount to the foreign seller.

In this regard, says Manasuev, it is important to act proactively.

“If you have been renting out the property but haven’t been filing U.S. tax returns, you should immediately come into compliance and file those returns. When you do apply for a withholding certificate, this sort of behaviour and those facts would be discovered and they might prevent the IRS from issuing you the withholding certificate and approve reduced or zero withholding on the sale,” he says.

Ultimately, individuals who own U.S. real property for personal use should also turn their minds to the question of U.S. estate tax and probate and whether they wish to have U.S. wills or powers of attorney completed for the property.

“Doing that ahead of time will ensure there are no complications in the future at the time of the sale.”

In cases where individuals wish to keep a U.S. property in the family, Manasuev cautions that transferring it without adequate consideration can trigger income tax, and also estate and gift tax consequences in some cases.

“Sometimes they want the property to stay in the family and in that case, they can do some trust planning. One of the effective ways to deal with probate, for example, is to put the property into a revocable trust which does not change the taxpayer for U.S. tax purposes yet it helps avoid probate fees and makes it simpler for the property to pass on to the beneficiaries,” says Manasuev.

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