Tax Issues on U.S. Real Estate Properties

When it comes to U.S. real estate properties, there are tax, financing and insurance issues that should be considered.

Here is a brief list of some of the issues you should consider carefully before you purchase a condo or rental income property in the U.S.:

Decide How Much You Want To Spend and Whether You Will Pay Cash or Need Financing.

If you can pay cash, consider converting the funds into U.S. dollars and putting the proceeds into a highly liquid U.S. dollar money market fund.  You will lock in a favourable exchange rate, collect some interest and have the money instantly available when you need it.

If you plan to take out a mortgage, the terms will depend on how you use the property.

  1. If you are buying a vacation home in the U.S. that isn’t your principal residence and you don’t rent it out when you aren’t in residence, you will generally need a 30 percent down payment and proof that you have three to six months of liquid reserves.
  2. If you plan to purchase investment real estate, such as a home you don’t reside in but rent out for the income, the down payment is likely to exceed 30 percent, determined on a case-by-case basis, and you may have to prove up to a year’s worth of liquid reserves.

You may find better terms at U.S. subsidiaries of Canadian banks.

Evaluate State and Federal Taxes.

Generally, state property taxes are calculated by multiplying the nominal property tax rate by the assessment ratio, or the percentage of the value of the property that is taxed, by the value of the property.  Approximately thirty-eight states levy both state and local property taxes.

Florida presents a more complicated situation.  The state has a two-tiered tax system that hits newcomers and part-time residents harder than longer-term residents.

On the federal level, you may have to file a U.S. tax return, while in other instances income from the property, or the proceeds of the sale of the property, will be subject to non-resident withholding taxes.

Taxability in the U.S. is determined by the concept of substantial presence, which is based on the total time you spend in the country over three years.  If you do not qualify, you are required to pay taxes in both Canada and the U.S.

There are legitimate ways to avoid double taxation, but you are responsible for knowing your residency status, the required tax returns and U.S. tax forms to file, and when and where to file them.  Ignoring the rules can result in very heavy penalties.  You should consult with your tax professional about these complex tax rules.

If you have rental income from U.S. property and do not fall into the deemed resident category, you do not have to file a U.S. tax return provided you withhold sufficient non-resident tax from the rent.  A 30 percent non-resident tax applies to gross rental revenue.  If you do not file, you cannot deduct rental expenses.

If you do file and report income as if you were a resident, you can deduct allowable rental expenses.

However, keep in mind that you also will have to report the rental income on your Canadian tax return, and may end up paying Canadian taxes.  You may be able to claim a foreign tax credit for the U.S. tax you paid.

If you dispose of a property in the U.S., you will be subject to U.S. tax on the gain on the sale.  In this case, you will not be subject to Canadian tax on the sale, because of the U.S. – Canadian tax treaty.  You will be required to file a tax return with the IRS, and may also be required to file a state tax return.

Don’t Forget U.S. Estate Taxes.

Unlike Canada, the U.S. has an estate tax that applies to any resident who owns property in the country.  The property is taxed at 45 percent if the deceased’s worldwide holdings are worth more than $2 million.

Some advisors recommend having assets outside of the U.S. owned by one spouse and assets in the U.S. owned by the other spouse or common law partner.  That way, the spouse owning the U.S. property pushes the worldwide estate to below the $2 million level.

Passing the house on to your children is not of much benefit, as the U.S. also has significant gift tax.

Be sure to talk to your accountant.  Finding a great property deal is more complicated than it might seem on the surface and you will want help to ensure you have covered all the angles, including insurance coverage which, in some states, can be very expensive, as well as the possibility of having to pay a 10 percent tax charged to foreign investors through the Foreign Investment Real Property Tax Act.

Conclusion

The U.S. tax rules are very complicated and professional advice should be obtained before any purchase is made.  If you have any questions, just call us at 905 528 0234, Extension 224 for Joe Truscott or email me at joetruscott@josephtruscott.com.