David A. Altro’s “Keeping a bargain a bargain” was published in the January/February 2010 edition of CAmagazine. We invite you to read below as David constructs a case study exploring the complexities of purchasing a property in the U.S. during today’s unique economic situation.
See how in David’s scenario, several key factors (i.e., a strong Canadian dollar and a depressed real estate market) favour U.S. real estate purchases by Canadians. Oriented towards Chartered Accountants, the article provides an in-depth analysis of the cross border tax and estate planning implications of this kind of transaction.
Download the article here (PDF) , or read it below.
Keeping a Bargain a Bargain
By David Altro.
US real estate is attractive, but a few tax and estate planning strategies can help you avoid tax and probate issues
With US sunbelt property values having decreased dramatically over the past few years and the Canadian dollar trading at reasonable levels, it isn’t surprising that a number of Canadians are contemplating purchasing a property stateside. To explore the crossborder estate and tax complexities of such a purchase, the following case study considers a Canadian resident couple planning to purchase a condo in Florida.
Brad and Angelina are married and are both Canadian citizens and residents. They have two children: Bonnie, 29, and Matt, 26, also Canadian citizens and residents. The couple plans to purchase property in Boca Raton, Fla., for US$1.5 million. They expect to close on the property with cash but plan to finance between 50% and 60% of the purchase price (between US$750,000 and US$1 million).
Brad’s life insurance policy has a face value of US$2 million; his total estate is worth about US$6.5 million (including a $2-million life insurance policy). Angelina’s estate is worth about US$8.5 million. Their total joint estate is worth US$15 million. They don’t own any shares or bonds of US companies and would like to lower their potential US estate tax liability.
Issues with holding property titles personally
Probate is the legal procedure required to transfer legal title to children or beneficiaries upon your death. As per Florida statutes, probate may cost up to approximately 3% of the value of the Florida estate (US$1.5 million) upon the date of death, which translates into approximately US$45,000 of probate fees and expenses based on the current value of the property. Of course, it is highly likely that the value of the property will have greatly appreciated at the time of death and that probate expenses would be significantly higher.
Other US real estate title ownership issues include an incapacity hearing and guardianship determination if you are deemed to be incapacitated. A guardianship proceeding is a legal proceeding under which a person who lacks the ability to manage certain functions of daily living is declared by a court to be incapacitated and loses the legal right to make certain decisions. The court must make a finding of incapacity then determine whether to appoint a guardian to exercise the decision-making rights that were removed. Guardianship proceedings re-quire legal representation and can be costly.
Since probate and guardianship procedures are also time consuming and freeze the estate, we would like to structure the couple’s estates so they avoid probate and guardianship procedures.
There are specific rules under the Internal Revenue Code and the US-Canada Tax Treaty regarding US estate tax applicability to a Canadian resident who dies owning US assets.
Those with less than US$60,000 worth of US domiciled assets avoid the whole US estate tax issue. Even where the US assets exceed US$60,000 on death, there may still be no US estate tax payable by applying the treaty as it provides that should the worldwide value of assets not exceed US$3.5 million (2009 rule, this exemption is subject to change under current code legislation and also pursuant to draft bills proposed to the Senate and Congress. At press time, a legislative clarification was expected before the end of the year) there will be no estate tax.
However, should the US assets exceed US$60,000 and the worldwide estate exceed US$3.5 million, there may be estate tax on death depending on the value and ratios of the US assets as the numerator and the worldwide assets as the denominator multiplied by the exemption, to determine the credit. The resulting credit is then subtracted against what would otherwise be the tax.
With no US estate planning, should Brad die first and in 2009, his estate faces a potential US estate tax liability of US$219,846 (see table above). This calculation is based on his worldwide estate of US$6.5 million in 2009 and his potential US$1.5-million ownership interest in the property. (Sec. 2040(a) of the code, the Contribution Rule, presumes that where husband and wife own jointly, the entire value of the property is included in the estate of the first to die.)
There are two ways to mitigate that tax if Angelina survives Brad. The first is a marital credit available under the code and the treaty. Brad’s asset basis is such that his estate tax would be eliminated. Upon the second spouse to die (assuming Angelina dies after Brad), her US estate tax liability will be US$410,220 (based on US$1.5-million value of the property and US$15-million worldwide estate), using the 2009 values and exemptions (although there is actually a credit when the second spouse dies shortly after the first).
If Angelina dies first, there will be a tax of US$42,000 even after applying the marital credit because of her higher worldwide estate. In such a case where the marital credit isn’t sufficient to eliminate the estate tax, a second approach would be for the surviving spouse to roll the US assets of the deceased spouse into a qualified domestic trust, which will form part of the crossborder trusts (CBT). In such case, the marital credit will not apply.
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