The purchase of a second home is an important decision that requires the proper preparation and ownership structure. As such, from the very first step, it is essential for a non-resident buying real estate in the United States to be properly informed of the applicable U.S. tax and estate laws.STEPS OF AN ACQUISITION IN THE UNITED STATES
The purchase of a second home is an important decision that requires the proper preparation and ownership structure. As such, from the very first step, it is essential for a non-resident buying real estate in the United States to be properly informed of the applicable U.S. tax and estate laws.
A U.S. licensed real estate agent or broker should assist and represent the buyer throughout the various steps of the purchase considering the particularities of the U.S’. real estate laws.
1) Purchase Offer: This legal document will namely include the purchase price, define the terms and conditions of the sale and purchase, and determine the closing date and delays.
2) Inspection & Financing: Once the offer has been accepted by the vendor, an inspection of the property is done within the delay stipulated by the Purchase Offer. If you finance the purchase by a financial institution, it may request an evaluation of the property. Furthermore, most loans in the U.S. are subject to Documentary Stamp Tax.
3) Closing: Legal transaction certifying your purchase will generally be done by a closing agent. The agent will proceed with the verification of the property’s titles, the land taxes, as well as the account statements for the condo fees and expenses. Finally, the agent will issue the Owner’s Title Insurance Policy. Before closing, certain documents will be prepared by the closing agent. This will normally include the Settlement Statement, the Deed, and the Title Insurance. It may also include various Affidavits.
The final stage of purchasing real estate in the U.S. is the signing of the legal closing documents and the transfer of the funds. Once the documents have been executed, the closing agent will register them in the county registry office in which the property is located. The documents may also be signed in Quebec before a Public Notary, as long as the procedures strictly comply with U.S. laws.
OWNERSHIP SRUCTURE FOR A PROPERTY IN THE U.S.
There are several legal ownership structures that can be used by the buyer depending on the circumstances and objectives. It is important to consider all aspects before acquiring the property.
This first step is too often forgotten but the buyer's decision may have a significant impact on the income tax and estate beyond. Just as a solid foundation may limit damage to a residence in case of hurricane, the choice of legal structure can minimize the financial impact of tax payable on sale or death.
a) Ownership by an individual: This is the simplest and most inexpensive way to own a property, given that an individual is subject to lower tax rates than a company.
However, the main disadvantages are the U.S. Probate fees and the potential application of U.S. estate tax upon death, as well as the unlimited liability of the individual.
b) Ownership by a Canadian company: Normally, the shares of a non-resident company are not subject to U.S. estate taxes and thus, this structure prevents the application of such taxes. There are nonetheless many disadvantages, such as higher administrative and legal costs, higher taxation upon the sale of the property, and the risk of tax implications to the shareholder.
c) Ownership by an American company: Although often used by Americans, there are generally no particular advantage for Canadian resident to purchase U.S. real estate through a U.S. corporation or L.L.C.
d) Ownership by a partnership: A significant advantage of this option is the possibility of avoiding U.S. estate tax while being subject to lower personal tax on the sale of the property. However this structure implies a few legal and tax related aspects that should be carefully analyzed prior to its implementation.
e) Ownership by a trust: There exist two possibilities for this ownership structure – the American Revocable Living Trust and the Quebec Trust. These are explained in more details in the following section.
ADVANTAGES AND IMPLICATIONS OF USING A TRUST
The American Revocable Living Trust: A living trust is a written legal document in which assets are immediately transferred to the trust, in accordance with the directives given by the client. The assets of the trust will be administered by the client during his life and transferred to his heirs upon his death. The client will be the trustee as well as the sole beneficiary during his lifetime in order to maintain the control, to avoid tax filing obligations and management fees. As trustee, full powers to sell, lease or mortgage the property are granted.
Specially designed for the United States, our cross-border living trust allows the client to be treated as the owner of the property, for both U.S. and Canadian tax purposes. In the event of the trustee’s incapacity, a substitute trustee named in the trust will manage the property. Upon his death, the substitute trustee will act as an executor and distribute the property of the trust according to the instructions of contained in the trust, without the intervention and supervision of the Probate courts.
Note that the use of an American Revocable Living Trust does not avoid U.S. estate tax. However, the trust does include terms that can postpone, reduce and even avoid such tax for the heirs.
The Quebec Trust: The use of an irrevocable Quebec trust can avoid the application of U.S. estate tax. However, such a trust implies that the contributor abandons the incidents of property or control of the trust assets and does not reserve certain administrative or substantive powers and cannot revoke the trust or acquire the trust property. Indeed, as a general rule, the Quebec trust will be treated as a distinct legal entity and patrimony for U.S. estate tax purposes, and the contributor will not be considered as the effective owner of the trust property.
For example, a Canadian resident may make a gift of cash to the trust in Quebec, which will allow the trust to purchase the U.S. property while designating the spouse and children as beneficiaries of the trust.
However, great care should be taken in drafting the trust document, in the choice of trustees and the powers given to the trustees and the beneficiaries.
U.S. ESTATE TAX PLANNING
Generally non-resident of the United States that own U.S. assets such as real estate or U.S. company shares can be subject to U.S. estate tax upon their death.
According to the Internal Revenue Code (IRC) in the United States, an American resident is subject to the estate tax upon his death, on the fair market value of assets worldwide. On the other hand, a non-resident is subject to U.S. estate tax upon his death, only the fair market value of property located in the United States. The U.S. estate tax ranges from 18% to 40% in 2013.
According to recent modifications in the legislation, an exemption of $5,250,000 is available to a U.S. citizen living in the United States for 2013. It should be noted that this amount is only available to a resident of the United States. Under the IRC, a non-resident is only entitled to a $60,000 exemption.
Furthermore, the Canada-U.S. Tax Treaty provides special relieving provisions regarding U.S. estate tax, essentially allowing Canadian residents to benefit from the same exemption available to a U.S. citizen (an exemption of $5,250,000), but only on a pro-rata amount, based on their U.S. taxable estate over their worldwide taxable estate.
For example, if a Canadian resident's U.S. assets are worth US $1million and its worldwide estate is U.S. $6.5 million, his U.S. estate tax liability would be US $31,000 should he die, in 2013.
Canadian resident individuals purchasing or owning significant U.S. real estate properties may consider various planning techniques to reduce or eliminate their exposure to U.S. estate tax. Tax planning possibilities generally are joint ownership of the U.S. property, use of a non recourse mortgage, use of a Quebec trust, use of a qualified domestic trust, gift of the U.S. property.
In all circumstances, it is important to properly analyze the U.S. and Canadian tax implications involved, a cost-benefit-risk analysis should be carried out and professional advice should be obtained before implementing any estate planning structure.
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