Caution is key for clients seeking U.S. real estate bargains

Buoyed by a slumping U.S. real estate market, a resurgent Canadian dollar and historically low mortgage rates, many Canadians are finding the temptation to buy property south of the border irresistible.

In Florida, a popular snowbird state, home prices are off between 30% and 40% from their peak, says Rosaline Cyr, president and CEO of Hollywood, Fla.-based Natbank, a subsidiary of National Bank of Canada. Other warm-weather states — such as Arizona, Nevada and California — have also seen big drops in real estate prices.

“Interest among snowbirds looking to buy in the United States is at a high this year,” Cyr says.

But if your client is feeling the itch to buy property in the U.S., he or she needs to be aware of myriad financing, insurance, taxation and estate issues related to owning U.S. real estate.

First off, with the U.S. lending market still in disarray, your client might find it difficult to obtain a mortgage from a U.S. bank.

“The U.S. financing market has all but dried up for Canadians,” says Terry Ritchie, a certified financial planner and partner with Transition Financial Advisors Group Inc., based in Calgary and Phoenix.

However, some U.S.-based subsidiaries of Canadian parent banks, such as Natbank and RBC Bank (USA), the latter an arm of Royal Bank of Canada, do lend to Canadians looking to buy U.S. property.

Also, Canadians can arrange for financing for U.S. real estate from their domestic bank, most often through a home-equity line of credit against a property in Canada.

Your clients should note that legal closing costs associated with buying U.S. property can be up to three times as high as they are in Canada.

Your clients should also know that although mortgage interest is tax-deductible for U.S. residents, that deductibility does not apply to Canadians who are buying a U.S. property for personal use.

Snowbirds will need to buy home insurance, as they do in Canada. In some states, they may also have to obtain hurricane or flood insurance, which can be expensive.

If your client will be renting out the property, he or she should be sure to have liability insurance, too. Canadians will have to obtain this insurance from a U.S. provider; clients should shop around and read policies carefully.

“Not all insurance policies are the same,” says Brian Wruk, a CFP and partner with Transition Financial, as well as co-author (with Ritchie) of The Canadian Snowbird in Canada (ECW Press, 2007).

Many Canadians believe that they are legally obligated to file a U.S. tax return if they buy a U.S. property. This is not the case. If no rental income is being derived from the property, there is no requirement to file a U.S. return.

However, if your Canadian client does rent out all or part of a U.S.-based property, he or she must remit 30% withholding taxes on the gross rent. In order to avoid or reclaim some of these taxes, your client would have to obtain a U.S. individual taxpayer identification number in lieu of a U.S. Social Security number, and file a U.S. tax return.

Any “ordinary and reasonable” expenses associated with the property could then be deducted against the rental income. There is also a deduction for depreciation on the property, which is man-datory under U.S. tax rules.

Finally, your Canadian client would also have to claim the rental income and expense deductions on his or her Canadian tax return. He or she could then claim a foreign tax credit on the taxes he or she paid in the U.S., thereby avoiding double taxation.

When your client sells the property, withholding taxes of 10% are levied on the sale price of the property. Some or all of these taxes may be refunded if the taxes paid exceeds the amount of taxes payable on the capital gain realized on the sale of the property.

However, if the sale price of the property is less than US$300,000, and if the buyer intends to use the property as his or her primary residence, the withholding taxes do not apply.

Canadians who sell property in the U.S. also have to declare any capital gain on their Canadian return, and they can claim a foreign tax credit for any taxes paid on the capital gain in the U.S.

@page_break@Beyond the federal tax burden, Canadians who own property in the U.S. may also owe state taxes, depending on the state in which the house is located.

Canadians who own property in the U.S. will also have to consider their potential U.S. estate tax liability. If a Canadian owns U.S. property valued at more than US$60,000, and if his or her worldwide assets exceed US$3.5 million, then estate taxes of up to 45% could be due on all U.S.-based property.

Some experts suggest that Canadians who are interested in owning U.S. property do so through a structure, such as a corporation, a trust or a partnership. However, ownership through one of these structures is usually useful only to very wealthy owners, and then only under certain conditions.

“It costs a lot of money to set up and maintain these structures,” says Tannis Dawson, a senior specialist in the tax and estate planning department of Investors Group Inc. in Winnipeg.

Finally, Canadian clients who own U.S. property have to be aware of U.S. gift taxes and how they might affect how clients own U.S. real estate. These taxes apply to gifts of tangible personal property — such as real estate — valued at more than US$13,000.

If a spouse owns a U.S. property in his or her name and later decides to include his or her spouse’s name on the property — perhaps as equal owners — gift taxes could be levied on half the value of the property.

However, there is an exemption that allows one spouse to gift a non-citizen spouse US$133,000 a year free of U.S. gift taxes.

IE