Release date: June 29, 2011
Guest: Beth Webel
Running time: 9:47 minutes
In this episode, Beth Webel discusses the implications of owning a vacation property in the U.S. Specifically, she covers the potential capital gains tax in the U.S. and Canada, estate taxes and what may happen if the taxpayer as owner of a property.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Gerry Lewandoski: Today we have the pleasure of talking to Beth Webel, a partner in PwC’s Hamilton office. Beth specializes in tax planning related to estates and trusts, family business succession planning strategies, charitable giving strategies, U.S. estate tax and cross-border trust planning. She is going to speak to us about the tax implications of owning a vacation property in the United States.
Thanks for joining us Beth.
Beth: Thank you, Gerry. It’s great to be here.
Gerry: Owning a family vacation property down in the U.S. sounds appealing, but I understand some significant tax implications need to be taken into consideration.
Beth: That’s right. The U.S. tax system is quite a bit different than Canada’s, and often that can lead to nasty surprises if a Canadian owner divests of the property. But planning ahead of the purchase can make a big difference.
Gerry: Now by “divest” – do you mean when it comes time to sell the property?
Beth: Yes, certainly selling the property is the most common, but a buyer should also take into consideration the possibility of U.S. estate tax if taxpayer actually dies while they own the property.
If you start with the simplest case – that’s when the owner decides to sell the property and they will realize a capital gain on the property. In very simple cases, and it gets more complicated if they rent, let’s assume that the property is not used as a rental property – even for a few weeks a year can cause the properties to be subject to tax on the rental income.
Gerry: OK, so we are assuming the owner is alive when it comes time to sell the U.S. vacation property.
Beth: Yes. In this case, there are U.S. income tax implications if you sell the property and there are capital gains.
Gerry: Are there also Canadian taxes on these same capital gains?
Beth: Yes, there’s also Canadian tax, but that’s generally not a problem. Canada will allow a foreign tax credit for any U.S. taxes paid on the gains – so there shouldn’t be any double taxation. In the U.S. you pay a 15% federal long-term capital gains tax rate. Canadian capital gains taxes are typically higher, so overall you would actually pay more than the 15%.
For example, in Ontario, the Ontario capital gains rate is 23% so the seller would end up paying overall tax at 23% - of which 15% goes to the U.S. federal government and the remaining 8% goes to Canada.
In Ontario most of our individuals purchase their properties in Florida and Florida doesn’t have any state capital income tax to consider, but other states like Arizona and California do have state income tax that would be in addition to the U.S. federal taxes paid.
You also need to take into account the impact of the U.S./Canadian foreign exchange on the sale. This can get tricky and it can have a significant impact sometimes and result in an unexpected overall gain or loss on the sale. Due to the volatility of the dollar over the past few years, this is very, very difficult to predict.
Gerry: From what you had said earlier, a purchaser of U.S. vacation property needs to also consider how the ownership of the U.S. property will impact their estate.
Beth: Absolutely. Tax at death is usually the bigger planning issue that we have with individuals buying property in the United States. The U.S. system bases estate tax on the value of the asset, not just on the capital gain on the property at the time of death. But the important thing here to note is that planning before the purchase can make a huge difference. I always advise potential purchasers to make sure they consult with a knowledgeable advisor in Canada before they purchase the property. They shouldn’t assume that a U.S. real estate broker or attorney is familiar with the issues facing a Canadian purchaser because the issues are very different than those facing U.S. purchasers.
Gerry: Can you explain how the U.S. system can create surprises for Canadians?
Beth: Sure. Basically Canadians that own U.S. vacation property that is worth more than $60,000 U.S., when they die, they’re subject to U.S. estate tax on that property. Their estate will have a U.S. filing obligation in that case.
Now, how large that U.S. estate tax bill is will depend on four factors. It’ll depend on:
Gerry: This sounds complex, Beth.
Beth: It is. And it can be a minefield for an estate if proper consideration isn’t made at the time of purchase.
The Canada/U.S. treaty provides Canadians with an exemption from estate tax. And that exemption is based on a formula which is based on the four factors I described above. In really simple terms, a Canadian gets a percentage of the exemption that’s available to U.S. citizens. That percentage is a function of the value of the U.S. property as compared to the value of the worldwide estate. So, for example, in 2011, if the Florida property represents 10% of the deceased’s worldwide estate, the deceased will get an exemption of $500,000. And that $500,000 is 10% of the current $5 million exemption that’s available to U.S. citizens.
Gerry: What type of actions should be considered to reduce the amount of estate tax owed?
Beth: Well, in the ideal world the individual would sell the property prior to death - but we can’t always recommend that as an option.
Everyone’s situation is different, but generally for smaller properties – let’s say less than $1 million, we usually see some form of personal ownership. Generally the treaty works fairly well and we can combine that with some will planning for the individual. For example, often it’s a good idea for the property to be owned by the spouse with the lower net worth as this will allow them to access a larger exemption under the treaty.
Or, sometimes we suggest structuring the purchase of the property at the outset as “joint tenants in common” so that each spouse can limit their tax exposure to 50% of the property.
With personal ownership though, the owner likely will want to consider some kind of will planning so that the property passes to a spousal trust under their will, which will protect the survivor from future estate tax.
Gerry: What happens if a property owner doesn’t give any thought to transaction or will structuring?
Beth: Well, I can present the worst case scenario, Gerry. A family vacation property valued at $1 million is held in the husband’s name. He dies and the property transfers to his wife along with a hefty $330,000 estate tax bill. Once that bill is paid, the wife unfortunately passes away, and she again is subject to estate tax and pays another $330,000 estate tax bill.
This exposure to double tax on the same asset is why it’s so important that we ensure that our clients have a fair structure so as to minimize the estate taxes.
Gerry: And what do people do for larger properties?
Beth: Well, because US estate tax at death is so different from Canadian taxation it’s generally a good idea for planning purposes, to carve out this U.S. property from the rest of the estate and treat it differently than the rest of the couple’s property.
In some cases, the estate tax exposure may be so large that we may have to look at placing ownership in some kind of entity, such as a Canadian family trust.
For 2011 and 2012, federal U.S. estate tax rates start at 18% and rise to 35% fairly quickly. I should note here though, that this is only temporary legislation and if no new legislation is enacted in 2013 the top rate will rise to 55%.
Gerry: So it sounds like there’s a lot to consider before you sign the cheque on a new U.S. vacation property, Beth.
Beth: There is a lot to consider and there is also a lot of “cocktail advice” around this issue which results in a great deal of misinformation. For further information, PwC has produced a Memo around this topic. You can go to our website at www.pwc.com/ca/tax and search “U.S. Estate Tax”, or consult your local PwC professional.
Gerry: That you for joining us Beth.
Beth: You’re very welcome. Thank you.
Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.