Given our winter climate, many Canadians choose to be “Snowbirds” and purchase property to winter in warmer climates in the United States (“US”).
Once this decision has been made as to where and what to buy, the structure of the purchase must be considered, so as not to conflict or be affected by various US and Canadian tax considerations. upon ownership or sale of the property, or death. of an owner.
From a Canadian tax perspective, if the property is not used to generate rental income and the money used to finance the purchase comes from the person buying the property, there is no Canadian tax consequences unless and until (a) the owner sells the property property for a profit or (b) dies while retaining ownership of the property and, in either case, the property has a fair market value at the time of death greater than its tax cost. In either situation, the owner will become subject to tax in Canada on the capital gain realized on the growth in value of the property.
The tax consequences in the United States are considerably more complex and, if not well planned, can result in significant tax liabilities that can be reduced or avoided with proper planning. A major difference between the Canadian and American tax systems is that in the United States, the “Estate Tax” is assessed on the gross value of the estate of the deceased person and not on the increases in value. For non-residents of the United States, estate tax is only levied on assets located in the United States, including property in the United States (as well as shares of United States corporations). Therefore, if a non-resident of the United States dies while owning real estate in the United States and is subject to estate tax, the tax is calculated on the basis of the total value of the property real estate, whether or not it has appreciated in value.
This means that a Canadian who has never been a US taxpayer is still subject to US estate tax on certain assets, including real estate held in the United States. Depending on the values, the property tax can reach 40% of the value of the property. There is no foreign estate tax credit that Canadians can use to reduce Canadian taxes.
There is currently an exemption from US estate tax where a deceased’s worldwide assets do not exceed US$12,060,000 in value. Therefore, when a Canadian dies with worldwide assets below this amount, no US estate tax will be imposed. The US exemption threshold is adjusted annually for inflation, but the current threshold is set to expire in 2026, at which time, if nothing else changes, the exemption threshold will be reduced to somewhere between 6 and 7 million US dollars. Importantly, as part of its tax reform, the Biden administration is seeking to reduce this exemption to an even lower threshold and potentially before 2026.
For many years, there was a fairly simple method of avoiding US estate tax on Snowbird property; that is, a Canadian company would hold the title. Upon the death of the owner of the Snowbird property, no US estate tax would result, as the corporation would continue to hold legal title to the property; the deceased held only shares of a Canadian company and had no assets located in the United States. For many years, it was the policy of the Canada Revenue Agency (“CRA”) not to take the position that the benefit of using the Snowbirds property without paying market rent to the corporation was a benefit taxable. Unfortunately, a few years ago the CRA changed its policy so that shareholders could no longer hold ownership of the Snowbirds through a Canadian corporation without becoming taxable on the shareholder benefit. This effectively put an end to the structure of Canadian corporations.
More recently, another popular method of limiting US estate tax has been a non-recourse mortgage. US estate tax is only levied on the value of the real estate net of any non-recourse mortgages on the property. Where there was no mortgage from a conventional lender, a mortgage could be given by one lender spouse to the other spouse who would use the money to purchase the property. Thus, the property’s only exposure to US estate tax would be to the extent that its value has increased from the original acquisition price.
To avoid the application of the Canadian Attribution Rules (which might otherwise apply to certain loans and gifts between spouses, resulting in the taxation of income from property purchased in the hands of the lender/donor spouse), the non-recourse mortgage between spouses was to bear interest at the prescribed rate established by the CRA, and the interest was to be paid annually. The lending spouse would have to declare and pay tax in Canada on this interest earned on the mortgage. For the past few years, the prescribed rate has been 1%. If the attribution rules applied, any taxable income from the Snowbird property would be attributed not to the owner, but to the lending spouse from whom the funds originated. It would also mean that any capital gains on the sold Snowbird property would, in Canada, be taxed in the hands of the lending spouse, not the owner spouse. An additional issue is that there would be a lag in the availability of the foreign tax credit: since there would also be a capital gains tax in the United States, which would normally generate a foreign tax credit against the he tax on the same gain in Canada, in the normal course, the person disposing of the property could use this credit to reduce his Canadian tax payable. However, if the gain was taxable in the United States in the hands of the owning spouse, but taxable in Canada in the hands of the lending spouse, it would not be possible to use the foreign tax credit generated by the United States tax against the tax in Canada.
Given the appreciation of real estate in the southern United States in recent years, the interest that will be required under the non-recourse mortgage structure will be based on a significantly higher principal amount and, taking into account Given the recent rise in interest rates, the prescribed rate set by the CRA will undoubtedly increase. This will result in a significant increase in tax that will be payable on interest earned by the lending spouse on loans made after the increase.
Although we still use the non-recourse mortgage to limit US estate tax exposure, over the past two years we have begun to use other structures, including “trusts”.
Where a family has an existing trust with the resources to fund the purchase of a Snowbird property and there would be no attribution resulting from a loan by the trust to the purchaser, we can still use the non-recourse mortgage structure, but there would be no obligation to charge interest or any resulting tax on the interest. This structure is available when the persons who contributed the assets to the Trust in the first place are no longer alive or no longer resident in Canada for tax purposes.
There are also ways to use Canadian trusts to acquire Snowbird property so that the Snowbird property does not form part of the users’ assets for US estate tax exposure. These trusts would never allow users to have any rights to the Snowbird Property other than by allowing a beneficiary of the trust to use the property, and ultimate ownership of the property would rest with other beneficiaries of the trust. trust; normally children or other direct descendants. Such a structure should be carefully designed to ensure that it negates ownership rights to the Snowbird Property by the funders of the trust, and also avoids any attribution rule issues.
The other issue to consider is the 21-year deemed disposition rule, which requires a Canadian trust to pay capital gains tax every 21 years on the increase in value of its assets. To the extent that the ownership of the Snowbirds in such a trust has appreciated significantly and the ownership of the Snowbirds is still held, it should be distributed to the beneficiaries, presumably children or other lineal descendants, before the 21st anniversary of the creation of Le Confiance.
One advantage, however, in such a structure is that it is essentially a form of estate freeze such that such Snowbird ownership could remain in the family without triggering capital gains tax on the users death. initials. Such a structure should also avoid exposure to US and Canadian probate fees on Snowbirds property.
There are, of course, many other considerations involved in buying Snowbird properties that are beyond the scope of this article. For more information or to answer any questions, please contact the authors.
The authors would like to thank Joseph Owens of Dickinson Wright US for his contribution regarding US estate tax. In addition to Dickinson Wright’s office in Toronto, the company has 18 offices across the United States, including Snowbird destinations like South Florida and Arizona.
This article originally appeared in the Jewish Foundation of Greater Toronto’s Giving Advice, Spring 2022 edition.