AUTOMOBILE DEDUCTION LIMITS FOR 2013

Once more the Ministry of Finance has failed to recognize the increased costs of owning and operating a vehicle as they announce the new numbers (that are the same as the old numbers since 2002) which are as follows:

The maximum price of a vehicle for capital cost allowance remains at $30,000 before tax.

The maximum lease amount that can be deducted remains at $800 before tax.

The maximum deductible interest expense on a loan to purchase a vehicle remains at $300 per month.

The tax-exempt allowance per kilometre has increased by $0.01 to $0.54 per kilometre for the first 5,000 kilometres and $0.48 for each additional kilometre.

PURCHASING A U.S. VACATION PROPERTY

As snowbird season begins it is a good time to update our readers on the many issues to consider when buying a vacation property in the U.S. According to the U.S based National Association of Realtors in the year ended March 2012 Canadians purchased over $16 billion dollars of U.S. residences representing 24% of all foreign purchasers.

When considering the purchase of a vacation property in the U.S. the considerations must include the true costs, immigration status in the U.S. and potential exposure to U.S. estate, gift and income tax. As the result of purchasing and making use of the property your exposure could become substantial if protective actions are not taken.

We will examine a number of issues that should be considered in purchasing a U.S. property. For the sake of simplicity we are assuming that the property is being purchased as a vacation property and not a full-time residence, that the purchasers are not otherwise U.S. taxpayers, residents or green card holders.

The issues to examine will be:
• Cost considerations
• Ownership/title options
• Income tax traps
• Tax implications on sale
• Estate tax

Cost Considerations

Most purchases involve condominium properties. This is a natural route for part-time living as it allows for your property to be maintained during the off-season and also provides a sense of security. The main issue to be considered when buying a condominium in the U.S. is that, in most states, the protections afforded by such jurisdictions as Ontario’s Condominium Act and similar acts in other provinces, are not available. Since the condo corporations do not have the same powers to lien units and do not have priority over other creditors, unpaid fees will have to be passed to the remaining owners. When the U.S. market got hit in 2008 this left many properties desperately short of cash as owners abandoned their properties. The resulting drop in value was looked upon by Canadians as a buying opportunity. However, the maintenance fees charged by the condominium corporation needed to maintain the property were not reflected by the drop in the cost of the property. Therefore maintenance fees can be substantially higher than the carrying cost of the property.

Other cost considerations are increased property taxes that result from a combination of the desperation of many U.S. jurisdictions to maintain services and a conscious decision to pass cost increases inequitably towards non-resident property owners who make less use of local services but are looked upon as a deeper pocket and one that can’t vote in any event.

Insurance costs have also increased and certain coverage, such as hurricane insurance in Florida or earthquake insurance in California is too costly if even obtainable.

Ownership/Title Options

Probably the most often-asked question by people buying a property is “Who’s name should we put it in?” The choices are numerous and can be confusing. We will briefly address each of the options:

Personal – Many purchasers put the property in their own name. It is simple and inexpensive, at least to begin with. If the purchase price is small it may be the best option. Spending money on a more complicated structure may not be justifiable. While the definition of “small” may be debatable it is always prudent to have a short discussion with knowledgeable advisors to help with this determination.

The main concern is usually related to U.S estate tax (see below) and the efforts required to avoid its impact.

One consideration in using personal ownership rather than joint is if one spouse has a very small estate and the other a large estate then have the spouse with the small estate purchase the property. The resulting use of the estate tax exemption should be maximized (see “Estate Tax” below).

Joint Tenancy (with survivorship)

This is also very popular and mostly used by couples purchasing property. The idea is that the title of the property will pass to the survivor of the joint tenants. While this works well for Canadian tax purposes, the U.S. implications can be more complicated. U.S estate tax assumes that the first to die paid for 100% of the property and therefore will include 100% of the value of the property in the first spouse’s estate. If the surviving spouse dies still owning the property the estate will again be taxed on the full value of the property. The result is double taxation for U.S purposes and no offset for much of it in Canada.

A second issue is that the IRS may try to apply the gift tax to a spouse who has not contributed funds for the purchase but has been included in title.

Tenants-in-Common

This is similar to joint tenancy except that the survivor does not necessarily inherit the property interest on the death of the first owner. The assumption of 100% funding in joint tenancy does not apply in this case so the estate tax would only be on the percentage of the property owned by the deceased. The IRS also recognizes a discount against a partial interest because of the difficulty of selling a partial interest to a third party. The usual discount is 15% of the otherwise determined value.

This would be a better estate tax result than joint tenancy and may allow for a better, though still not complete, offset from Canadian tax. One additional consideration is that probate would apply in this method which is avoided in joint tenancy but the cost is usually nominal compared to the estate tax costs.

Canadian Partnership

In previous versions we had suggested that a Canadian partnership may be a viable option as it was considered, by many practitioners, to be unaffected by U.S. estate tax. However, the IRS has signalled that it may deem the partnership to be a U.S. trade or business. This would not be favourable. While the option to elect the partnership to be taxed as a corporation for U.S tax purposes the election must be made within 75 days of the death of the taxpayer which places a substantial burden on the family and an issue that may be lost in the aftermath of a death.

Canadian Corporate Ownership

This option is no longer viable as the result of changes in the Canada-U.S. Tax Treaty. You could be assessed for the taxable benefit of the value of the property. In addition, the IRS has indicated that it would consider ignoring the existence of a Canadian sole-purpose corporation meant to avoid U.S estate tax though we have seen no actual incidence as yet.

U.S. Corporate Ownership

Many U.S advisors not conversant with cross-border issues will advise that Canadians use a U.S. LLC to purchase a property, which is quite a normal action for a U.S taxpayer. For Canadian taxpayers these do not work for a number of reasons. They do not protect the owner from any U.S estate tax, the LLC is taxed as a partnership in the U.S. but as a corporation in Canada so it will result in double-taxation. The taxable benefits mentioned under Canadian Corporate Ownership above will also apply in this case.

Some advisors also suggest a revocable trust. Again this is considered a separate entity in Canada for tax purposes and will result in double-taxation.

U.S Real Estate Trust

This entity will provide a vehicle for the purchaser to avoid U.S. estate tax. The settlor must contribute all of the cash to purchase the property. The settlor cannot be a beneficiary or trustee. The trustee can be the settlor’s spouse and the beneficiaries can be the spouse and children. The property is purchased in the name of the trust. While the settlor can have no other dealings with the trust he or she is allowed to contribute funds to the trust on an ongoing basis to cover operating costs.

The death of the settlor will not affect the trust or result in any estate tax. Estate tax will result when a beneficiary dies but that can be reduced by having multiple beneficiaries.

The 21-year rule for Canadian trusts should be kept in mind and appropriate measures should be taken to deal with that limitation.

Non-Recourse Mortgage

U.S. estate tax is calculated on the net assets of the deceased taxpayer. In the case of non-residents of the U.S. the net assets are the U.S situs assets only. A deduction is available for a non-recourse mortgage as it is directly tied to the U.S property and cannot be satisfied by any other asset of the deceased. This is a difficult funding to obtain. It must be a loan from a third party and most financial institutions are not prepared to lend in this manner and, if they are, the loan to value ratio will be lower and the interest rate much higher than normal market conditions.

Life Insurance

This may be one of the easiest and least costly manner of preparing for U.S estate tax however since many purchasers are older and may have health issues the costs may be prohibitive. The insurance proceeds are not taxable but they may reduce the exemption as they are included in worldwide assets (see Estate Tax below).

A Canadian insurance policy is a much better option and usually more affordable.

Income Tax Traps

One of the biggest traps is if the property is rented to another user. U.S. withholding taxes on the rents are required and U.S. Federal, and possibly state, returns must be filed as well as Canadian tax reporting.

One of the biggest traps in the number of days spent in the U.S. Many snowbirds assume that as long as they don’t spend more than 180 days in the U.S. they have no U.S. tax problems however the rule is more complicated and the actual calculation is that if you spend more than 120 days in the U.S. every year you may be subject to U.S. tax. In order to protect yourself from incurring an unintended U.S tax liability you would have to file an election known as a “Closer Connection Exception” form 8840 every year.

Tax Implications on Sale

When the property is sold it is subject to FIRPTA withholding which is 10% of the gross sale price. This withholding can be reduced by filing a waiver application with the IRS to reduce the tax based on the actual gain from the sale. The waiver request must be filed prior to closing.

The sale will also result in the requirement for a Federal, and possibly state, tax return reporting the gain on sale.

Estate Tax

U.S. estate tax always deserves repeating as its impact can be unexpected and severe. The U.S. taxes all U.S. situs assets on the death of a non-resident. This includes U.S. property and holdings in U.S. equities even if they are held within a RRSP, RRIF or other Canadian sheltered entity (but not a Canadian corporation). The estate tax is on the net asset value of the estate. For 2012 the exemption was $5 million and the tax rate was 35%. However a non-resident would only have an available exemption based on the pro-ration of U.S. assets as a percentage of worldwide assets. Therefore a $10 million estate where $1 million is U.S. assets the exemption would be limited to $500,000 ($1 million/$10 million). In this example the estate tax would be $175,000 ($500,000 x 35%). It is possible that little or none of this tax would be available for a foreign tax credit in Canada depending on the circumstances.

It is anticipated that the 2013 exemption, barring Congressional action, will be reduced to $1 million and the tax rate increased to 55%. In our above example the 2013 U.S. estate tax would be $495,000 ($900,000 x 55%).

PGC NEWS

Please note that the filing deadline for most trust returns is April 1.

The filing deadline Canadian tax returns is April 30.

The filing deadline for Canadian self-employed tax returns and U.S returns for non-residents of the U.S is June 17.