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Tax issues of owning U.S. property

(Special) - Many Canadians dream of owning a piece of the sunny South. That dream can have some real tax implications, however, that need careful consideration before you actually take the plunge and buy a bit of paradise in the sun.

(Special) - Many Canadians dream of owning a piece of the sunny South. That dream can have some real tax implications, however, that need careful consideration before you actually take the plunge and buy a bit of paradise in the sun.

Before you actually go ahead and buy you have to consider ownership because that can determine whether or not you will pay U.S. estate tax.

Under new rules contained in the recent fiscal cliff agreement, Canadians do not have to pay U.S. estate taxes on U.S. property if their world-wide assets are less than $5.25 million. This limit was increased from the previous limit of $3.5 million which was set in 2009.

U.S. estate tax often is greater than Canadian tax. It is based on the fair market value of the property at the time of your death. It starts at 18 per cent and goes up to 40 per cent for properties worth more than $1 million.

You can reduce your estate tax liability by claiming a tax credit, referred to as the unified credit, equal to the greater of either $13,000 or $2,045,800 (the estate tax on $5.25 million for 2013) multiplied by the value of your U.S. assets divided by your worldwide assets.

If your U.S. home accounts for 15 per cent of the value of your worldwide estate you would be entitled to a unified credit of $306,870 ($2,045,800 x 15%).

An additional credit also is available if the U.S. property passes to a Canadian spouse. In many cases these credits will actually eliminate the U.S. estate tax liability, although the estate still may be required to file a U.S. estate tax return to reclaim the credits provided for in the Canada-U.S. tax treaty.

The most common ways used by Canadians to purchase U.S. property are personally, jointly with their spouse or partner, or through a trust.

Personal ownership may be appropriate if the estate tax can be eliminated through the credits. In the case of a married couple, the best approach may be to put the ownership in the name of the spouse with the lowest net worth.

If you own the property personally, nothing happens until you sell the property, when a 10-per-cent withholding tax is taken off the sale price unless the property is sold for less than $300,000 and is sold to a U.S. taxpayer.

If you have owned the property for less than 12 months you will pay capital gains at the U.S. marginal rate (of 35 per cent), but if you've owned it for more than 12 months you will pay a federal capital gains tax of 15 per cent. You will have to pay tax on its disposition in Canada, but you do get a foreign tax credit in Canada for any tax paid on the disposition of property in a foreign country.

If the estate tax can't be eliminated by credits, it may make sense to set up a Canadian family trust to own the property, in which case estate tax may be avoided on the death of both the individual and the spouse, and if the property is sold, any increase in the value will be subject to the same capital gains rates as if the property were owned personally.

"In most cases people are under the threshold, but it's important to consider ownership at the beginning because it is very difficult to change ownership once the property is purchased," says Tannis Dawson, a senior tax specialist with Investors Group

If you spend more than 180 days in the U.S. over a three year period the three-year rule might come into effect. The U.S. will consider you a U.S. taxpayer and you will have to file a special form to prove you have a close connection to Canada and are exempt from paying U.S. personal income tax. The 180 days is determined by the number of days you spent in the U.S. in 2012, plus one third of days in 2011 and one sixth of days in 2010.

"A lot of people don't know about the rule," Dawson says. "With new passports it's a lot easier to police the amount of time people spend in the U.S. It's easier just to file the form and be done with it than to find out you are in violation of the rule and have to file, because once that happens the U.S. does not have to adhere to the treaty. It's a lot more difficult then."

Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors.

Copyright 2013 Talbot Boggs

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