Many US residents own Canadian recreational property. What are the issues to be aware of?

Implications of Ownership:

There are no annual income tax compliance or reporting issues related to holding Canadian real estate for recreational or personal use only.  However, it is important to retain documentation to support the cost of any capital improvements made to the property, as such amounts may be added to the ACB of the property to reduce a future gain on sale.

Implications of Sale:

A US purchaser of Canadian real estate will eventually be subject to Canadian income tax on the disposition of direct or indirect interests in real estate that are “taxable Canadian property”.  One-half of the capital gains is included in the calculation of income for Canadian tax purposes.  Assuming they had no other income subject to Canadian income tax, US-resident individuals would pay Canadian federal tax on taxable capital gains at marginal rates ranging from 20.5% (on the portion of taxable capital gains below $300,000) and 43.7% (on the portion of the taxable capital gain exceeding $100,000).  At top marginal rate, the effective rate of tax imposed by Canada on the capital gain would be 21.85% (43.7% times ½).

With some limitations, US residents should be able to deduct the Canadian income taxes as a credit against their US federal tax liability in respect of the gain realized on sale.  The same may not hold true for any state taxes that may be payable by the US individual on the gain, as some states, such as California, do not grant foreign tax credit relief to their residents for the purposes of computing state income taxes.

Implications of Death:

Canada currently does not impose estate taxes.  However, capital gains accruing during the lifetime of a tax payer (including non-residents) are subject to income tax on death.  For Canadian income tax purposes, when an individual dies, the person is deemed to dispose of all of his capital properties for their then fair market values and is required to pay income tax on any capital gains realized.  The executor acting on behalf of the non-resident decedent must file a Canadian income tax return for the year death and pay any Canadian income tax resulting from the deemed dispositions.

The beneficiaries of the deceased’s estate are considered to have acquired the real property at a Canadian tax cost equal to the deceased’s deemed proceeds of disposition.

The Canada-US Income Tax Convention (“the Treaty”) provides some relief from Canadian income tax to deceased US residents who leave taxable Canadian property to a surviving spouse or to certain trusts established on death for the benefit of the surviving spouse.  The Treaty also provides US citizens credit against their US federal estate tax liability for Canadian income taxes payable in respect of the deemed disposition of taxable Canadian property on death.

Solutions:

Trusts:

A Canadian resident trust could be set up for probate avoidance, creditor protection and potential long term capital gains tax deferral purposes. This should be done at the outset of ownership, as there are capitals gains and property transfer taxes payable if the property is transferred into a trust after the fact, which could easily outweigh probate fees (about 1.4% of gross assets in BC).  Property transfer taxes are computed at the rate of 1% of the first $200,000 CDN of the fair market value of the transferred property and 2% of the remaining fair market value.

Basic Estate Planning Documents:

US residents could do simple wills and enduring powers of attorney in the province in question to facilitate estate planning and property management goals. The costs are relatively inexpensive to set up these basic documents.

Watch Out:

US estate planning lawyers occasionally advise clients to transfer their Canadian real estate holdings into their US revocable trusts. Transferring a property into a US revocable trust would create an immediate taxable capital gain.  Also, the BC Land Title Office won’t allow the registration of a foreign trust in any event.

Please don’t hesitate to contact the lawyers and staff of Heritage Law for further information.