Considerations for U.S. Owners of Canadian Real Property
“Considerations for U.S. Owners of Canadian Real Property,” that’s the subject of today’s ACTEC Trust and Estate Talk.
This is Alvi Aggarwal, ACTEC Fellow from Fairfax, Virginia. U.S. citizens who own Canadian real estate face complex tax and estate planning issues. What are the traps in U.S. estate planning with Canadian real estate? ACTEC Fellow Amanda Stacey from Vancouver, British Colombia, Canada is with us today to explain Canadian taxation and offer some recommendations to planners. Welcome, Amanda.
Estate Planning with Canadian Real Property: Residency
Thank you, Alvi. Today I’m going to discuss at a high level some of the challenges of owning Canadian real estate for a non-resident of Canada. It’s worth starting with a short primer on Canadian taxation. Canada taxes individuals based on residency. If you’re considered a Canadian resident for tax purposes, then you are liable to pay taxes in Canada regardless of whether you are a citizen of Canada. If you were not a resident of Canada, you can be taxed, among other things, on dispositions of what is called “taxable Canadian property.” One example of taxable Canadian property is real estate located in Canada.
Care should be taken to ensure that you don’t inadvertently become a Canadian resident. There are two tests – factual residency and deemed residency. Factual residency is the place where you normally live. There are many factors that go into the test, but that’s the crux of it. Deemed residency can happen when an individual spends 183 days or more in Canada in a year. Although there is some relief available under the Canada-U.S. treaty, there are tie-breaker provisions that can provide relief where the individual is resident in another country with closer ties to that country than Canada.
Estate Planning with Canadian Real Property: Traps, Trusts and Taxes
With respect to the ownership of Canadian real estate, a lot of planning that U.S. citizens undertake for the purposes of U.S. income and estate tax does not mesh well with the Canadian income tax regime. I’m going to quickly highlight the issues with owning Canadian real estate in a trust or a corporation. If Canadian real estate is owned by a trust, for example, even a trust that is controlled by non-Canadian resident trustees, there are a number of Canadian tax issues that can result. For starters, if Canadian real estate is transferred to a trust, the owner will be deemed to have disposed of the real estate, and if there is a latent gain on the property, it will be taxed as a capital gain in Canada.
This will trigger the requirement to make filings, pay taxes, and apply for a clearance certificate from the Canada Revenue Agency, which we refer to as the “CRA”, which is the Canadian tax regulator. As well, the transfer of the property will likely trigger payment of property transfer taxes depending on the province where the real estate is located. The problems don’t end there, however. Once the property is held by the trust, the trust will have a deemed disposition event every 21 years, which will cause a further capital gain to be recognized, tax payable on that gain, and the need to obtain a clearance certificate from the CRA.
I’m often asked by U.S. advisors whether a U.S. person who holds Canadian real estate can create a Canadian will that pours over to the U.S. person’s revocable living trust. Unfortunately, under Canadian law, the use of a pour-over clause in a will requires that the recipient trust be non-revocable, unamendable, and signed with the testamentary formalities required by the province where the real estate is located. In my experience, none of these requirements are met by the typical U.S. revocable living trust, and, if done, the use of a pour-over in a Canadian will require a new trust that meets the strict formalities required under Canadian law. Another common U.S. planning technique that causes issues in Canada is ownership through a corporation, including an LLC.
Estate Planning with Canadian Real Property: LLC Ownership
Under Canadian tax law, LLCs are opaque and taxed as corporations. LLC structures are common in Canada for income-producing or commercial property. However, for personal use property, they are not a good ownership structure. Where real estate is transferred to a corporation, the same issues arise that arise where real estate is transferred to a trust. As well, once held by a corporation, there may be a personal benefit attributed to the shareholder under Canada’s income tax act.
Essentially under this rule, where a shareholder or an individual who does not deal at arm’s length with the shareholder, for example, a spouse, child, or parent, where they use the property owned by the corporation and they don’t pay rent for such use, our income tax rules will attribute a benefit to that individual equal to the fair market value of the rent to use the real estate. What that rent is would be determined by looking at comparable properties, the time spent at the property, and what the property would rent for to an arm’s length party. This benefit will be included in the individual’s income and taxed as income.
This applies equally to nonresident corporations that allow nonresident shareholders, or individuals not at arm’s length, to use Canadian real estate. In those circumstances, the rent is deemed to have been paid to the individual as a dividend from the corporation, and under the Canada-U.S. treaty, generally speaking, this dividend is taxed at 15%.
Estate Planning with Canadian Real Property: Personal Ownership
At the end of the day, the best way for a non-Canadian resident to own Canadian real estate is by owning the property personally. Where a nonresident owns Canadian real estate personally, I would recommend that they make a will in the province where the real estate is located. This will simplify the estate administration process. It is possible to probate a U.S. Will in Canada, but it will usually slow the administration of the estate because the U.S. Will should be probated first.
If there is no need to probate a will in the U.S., then it is important to have a Canadian Will that deals only with Canadian property, so that what is called an originating grant is not required to be obtained in Canada. Depending on the province of residence, an originating grant will require probate fees to be paid on a wider selection of assets than if a Canadian Will had been done. I should note that if the property is owned in the province of Quebec, then it is possible to have what is called a “notarial will” prepared, which will avoid the probate process entirely in that province.
Estate Planning with Canadian Real Property: Taxes and Ownership Prohibition
Finally, there are a number of new taxes applicable to ownership of real estate by nonresidents, as well as property that is not used regularly; that could be applicable to vacation properties held in Canada. Federally, we have an underused housing tax that requires certain Canadian private companies and individuals as well as nonresident, non-Canadian owners to file an annual return for specific types of residential property they own, and also determine whether they are liable for a 1% annual tax on that property. British Columbia imposes a speculation and vacancy tax on residential properties located in certain geographic regions in the province in order to target foreign and domestic homeowners who do not pay tax in the province. Similarly, Ontario imposes an underused housing tax at a rate of 1% annually on the ownership of vacant or underused housing in Ontario, and it is also applicable to nonresidents and non-Canadian owners.
I will end with this – there is currently a temporary ban on the purchase of certain Canadian real estate by foreigners. The new, perhaps aptly named, Prohibition on the Purchase of Residential Property by Non-Canadians Act, provides that since January 1st, 2023, it is prohibited for a non-Canadian to purchase, directly or indirectly, any residential property that is within the geographic regions defined by the act. This act is set to be repealed in January, on January 1st, 2025. This new law applies penalties in the form of fines up to $10,000 for the non-Canadian purchaser and every person or entity that knowingly counsels, induces, aids, or abets the non-Canadian or attempts to do so. Because of the division of lawmaking powers in the Canadian Constitution, because this is federal legislation, the law can’t actually stop a sale from happening. But if a sale does proceed, in addition to the penalties I just mentioned, the governmental body responsible for enforcing this law may apply to the court within the province in question for an order to have the property sold.
As listeners can now appreciate, the interplay between Canadian and U.S. planning can be complex with respect to the ownership of Canadian real estate. I would recommend advice be sought from a Canadian expert when planning for clients who own property in Canada. Thank you.
Thank you, Amanda, for that overview and for putting U.S. advisors in a better position to avoid some of the planning pitfalls in dealing with Canadian real estate for U.S. citizen clients going forward.
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