Do you have your eye on a villa in Tuscany or a ski chalet in Vermont? Or do you already head south to your beach house or condo in Florida to escape the Canadian winters? Before you jump into foreign property ownership or if you already have, you may want to consider what implications foreign property ownership has for you and your estate. Navigating the intersection of Canadian and foreign law requires looking in both directions.
Renting your foreign property may require you to disclose information to the Canada Revenue Agency (the “CRA”). A Foreign Income Verification Statement is required to be filed with the CRA where the adjusted cost base of the property exceeds CDN $100,000. This filing requirement does not apply to “personal-use property” where the time of personal occupancy exceeds the time rented out. Additional Canadian filing requirements apply if the property is owned by a foreign corporation or trust.
Penalties are imposed for failure to disclose. These include:
Foreign Property (T1135):
$25 per day up to a maximum of $2,500 plus interest
Foreign Corporation (T1134):
$2,500 per year
Foreign Trust (T1141 or T1142):
$2,500 per year
These penalties grow for Canadian residents grossly negligent in failing to file. Don’t be grossly negligent.
A Gain is a Gain, But a Loss is Not a Loss
Typically, when you dispose of capital property it creates either a capital gain or a capital loss. Half of a capital gain is taxable income. However, half of a capital loss is not a deduction. Instead, it may only be used to offset capital gains. Worse, when you dispose of “personal-use property” (e.g., your foreign owned vacation property) any capital losses are deemed nil.
Realized gains may also be taxed in the foreign jurisdiction. You may be able to avoid double taxation by claiming the foreign tax credit for the lesser of the actual foreign tax paid and the Canadian tax payable on the gain.
Imagine you own a property in Florida, which you acquired on March 1, 2010 for USD $250,000. You then add a lanai to the property on October 1, 2013 for a total cost of USD $50,000. You sell the property on May 1, 2020 for USD $500,000. Upon the sale of the property, you have a capital gain of USD $200,000, which means you pay the IRS tax in the amount of USD $40,000.
The capital gain is calculated, in Canadian dollars, by subtracting the total of the price originally paid plus the cost of any capital improvements (i.e., the adjusted cost base) from the proceeds of sale, while taking into account the exchange rate on each financial milestone, as shown below. It is not as simple as translating the US capital gain into the Canadian dollar equivalent.
Adjusted Cost Base:
$250,000 x 1.0486 (exchange rate)) + ($50,000 x 1.033 (exchange rate)) = CAD $313,800
Proceeds of Sale:
$500,000 x 1.4207 (exchange rate) = $710,350
Canadian Capital Gain:
Expanding the Estate Plan
Owning property in a foreign jurisdiction has some thorny implications for your estate plan. A secondary or tertiary Will may be required. An ancillary probate grant may also be required in the foreign jurisdiction.
An alternative method may be to have a foreign Will executed in accordance with the foreign law where the foreign property is located. Take caution not to revoke your existing Canadian Will(s). Navigating the various laws can be tricky, not something to tackle alone.
An additional Power of Attorney will also be required in the foreign jurisdiction in order to deal with the property should something happen to you and you are unable to make certain arrangements (e.g. sell the property, pay the taxes, etc.). You will also have to meet certain execution requirements and ensure they do not revoke your existing documents.
Estate taxes are imposed around the world upon the value of assets of a deceased individual before distribution to heirs. In fact, Canada stands alone among G7 countries and in the minority among the 37 OECD countries in not imposing a national estate tax. Even with the trend of rising exemptions in many of these countries, the fact that estate tax often applies to non-residents that own assets in the country means that Canadians contemplating owning a foreign vacation property ought to first consider steps to avoid or minimize their application.
The most commonly encountered estate tax for Canadians is the one imposed by our southern neighbour. An estate tax return is required if the deceased owned US assets with a total value over USD $60,000 at the time of death. The current exemption from tax is USD $11,580,000, but this exemption is prorated for Canadians on the basis of our US assets owned as a percentage of total worldwide assets. The tax rate reaches 40%.
A deceased Canadian resident owns a Vermont chalet with a fair market value of USD $2,000,000 at time of death on June 1, 2020. Their worldwide estate is USD $20,000,000. The irrelevant cost of the chalet was USD $3,000,000.
Gross Estate Tax:
$345,800 (the amount payable on the first $1,000,000) + 40% of $1,000,000 = $745,800
$4,577,800 x 10% (the percentage of US assets included the worldwide estate) = $457,780
Net US Estate Tax:
By Treaty, the US estate tax may be claimed as a foreign tax credit to reduce Canadian tax on the capital gain arising on death – that is, if there is a capital gain. Otherwise, it is just a tax to be paid, unless you plan.
Estate Tax Planning
The key to avoiding estate taxes is usually not to own property in the foreign jurisdiction. Of course, this makes enjoying a vacation property somewhat difficult. What we mean is to structure ownership by interposing a Canadian corporation or a Canadian trust between individuals and the property. Since the corporation or trust survives the death of individuals, the estate tax often does not apply. This is the case in the United States if the corporation or trust is organized properly. Canadian tax must also be considered in this planning to minimize tax during the ownership period.
If avoiding ownership is not possible, then the next step is to look for strategies either to reduce the value of the asset that is subject to the estate tax or to look for available deductions or deferral opportunities. These may include placing a mortgage on the property, making bequests to a surviving spouse, or claiming available tax treaty benefits.
Please note we are not US lawyers and US counsel should be consulted on any estate tax plan.
Weaving through the intersections of laws without hitting potholes can be done. By all means, shop for those villas in Tuscany, ski chalets in Vermont or Florida condos. Just map your route before you close. And please invite your lawyer for a visit!