US Rental Properties and US Property Acquisitions

Introduction

When it comes to U.S. real estate properties, there are 3 basic considerations including tax, financing and insurance issues that require very careful consideration.

This is a simple list of issues you should consider carefully before you buy that winter condo or rental-income property south of the border:

Considerations

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 highly liquid U.S. dollar money market fund. You will lock in a favorable 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 out when you aren’t in residence, you will generally need a 30 per cent 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 live in but rent out for the income, the down payment is likely to exceed 30 per cent, 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. 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 fail the test, 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 forms to file, and when to send them in. Ignoring the rules can result in heavy penalties. You should consult with your tax professional about these complex tax rules.

If you have rental income from your U.S. property and don’t 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 per cent non-resident tax applies to gross rental revenue. If you don’t 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 sell 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. -Canada tax treaty. You will be required to file a tax return with the IRS, and may 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 per cent 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 doesn’t really help much, as the U.S. also has a significant gift tax.

Conclusion

Be sure to talk to your Chartered Accountant. Finding a great property deal is more complicated than it might seem on the surface and you will want to 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 per cent tax charged to foreign investors through the Foreign Investment Real Property Tax Act.

Joseph A. Truscott has been providing income tax advice and tax planning suggestions to his clients for over 30 years. If you require his assistance in completing a US Income Tax Return and/or US tax planning issues, please contact Joe Truscott, Chartered Accountant at 905-528-0234, or email Joe at joetruscott@josephtruscott.com.

August 2012