Cross Border Tax Planning for Purchasing U.S. Property

Are you a Canadian high net worth individual looking to purchase a property in the U.S.?

There are many different ways that you might hold title to your U.S. property, which we presume, is a personal use, recreational house or condo in the Sun Belt.

Instead of describing all the possibilities and explaining the pitfalls of each structure, let’s zoom in on a special type of trust: the Cross Border Irrevocable Trust (CBIT).

If drafted correctly, the CBIT may eliminate the entire U.S. estate tax liability upon your death, potentially saving you thousands, or millions, of dollars down the road.

The CBIT is also a great tax-efficient way to leave your estate to the next generation, such as your children.

But the CBIT is not for everyone. Nothing is perfect and every situation and family dynamic is different and needs to be analyzed carefully.

Here is what you need to know.

The Parties to the CBIT

In the CBIT, there are two important parties: the trustee and the beneficiary (or beneficiaries).

We like this trust for clients who have kids and want to leave their estate to the next generation. For these clients, their kids would be the beneficiaries.

The CBIT is an irrevocable trust, so you should be comfortable with your choice of beneficiaries although the trust does provide for limited flexibility.

The trustee can be a spouse and/or an independent person (not a beneficiary).

The independent person need not be a corporate trustee. Why pay money to an institutional trustee when it’s a personal use property with no rental income?

If there is an independent trustee who dies or becomes incapacitated, the CBIT has a replacement mechanism.

Purchasing the Property

Once the CBIT is prepared, reviewed, signed, sealed and delivered in accordance with U.S. tax and trust law, while complying with the applicable Canadian laws, it is ready to be the buyer of your property.

Make sure you get the right advice from a cross border attorney on how to appropriately fund the CBIT and how and from where the money should be transferred to the U.S. title and escrow company to pay for the purchase.

After the dust settles, you and your family can now enjoy the use of the property.

And if you decide to buy a second U.S. property, it can go right into the CBIT as well.

Selling the Property

If you decide to sell and there is a profit, the capital gains tax will be at the minimum Internal Revenue Service (IRS) tax rate of 15% on the net profit (19.6% if gains are over $400,000).

Canadian capital gains tax will also be due, but the tax paid by the CBIT to the IRS will be preserved and applied as a foreign credit against the tax payable to the Canada Revenue Agency (CRA). No double taxation!

If you and your spouse decide to sell, nobody has died, and you don’t want another U.S. property, the money from the proceeds of the sale goes into the trust.

The money should get wire transferred into the bank account for the CBIT back in Canada. After that, you can either leave the money in the CBIT or take it out.

By the way, if you will need a mortgage from a U.S. bank for your purchase, it’s important to have your cross border attorney confirm with your U.S. mortgage lender that it understands that title will be in the CBIT and that the lender will provide a mortgage on property owned by a trust.

American banks have some lending restrictions. I suppose it’s because of their overly lenient prior lending practices that resulted, in part, in the U.S. banking disaster.

Benefits of Using the CBIT

If drafted correctly, the CBIT may eliminate the entire U.S. estate tax liability upon your death, potentially saving you thousands, or millions, of dollars down the road.

How do you know if your estate will be subject to U.S. estate tax? The answer depends on the worldwide value of your estate upon death.

U.S. estate tax applies where a Canadian passes away with U.S. real estate worth over $60,000 USD and a worldwide estate value over $5,490,000 USD (as of January 1, 2017).

The tax rate is 40% on the U.S. property less a pro rata credit.

If this scenario applies to you, strongly consider using the CBIT so that the property is owned by your trust, not personally.

By using the CBIT, if you pass away, there won’t be any U.S. estate tax payable by your estate or that of your spouse upon their subsequent death because trusts bypass your estate.

Additionally, it won’t matter whether the worldwide exemption amount goes up or down now or in the future.

Your kids also get the protection in the trust from their personal creditors, if any. Should your son or daughter get divorced, the ex-spouse can’t get at the property inside the CBIT because it won’t be considered a marital asset.

What if I Already Own the Property?

Things become somewhat more complicated if you already purchased a property in your personal name and now find out that you have a U.S. estate tax problem.

There are additional steps to go through to get your property into the CBIT. It needs to be carefully structured, for sure.

Many of our clients come to us after they have already purchased as they may not have been aware of the issues at that time.

It is important to determine whether the property has appreciated in value. We do not want to trigger a capital gain tax upon the transfer to the CBIT.

With proper structuring, there are strategies that help to both alleviate the U.S. estate tax hit upon death and to avoid the requirement to probate the estate in the county where located upon your passing.

Are you looking to purchase a property in the U.S. anytime soon?