If you are a Canadian high net worth individual with a U.S. property, will your estate upon your death be subject to U.S. estate tax? U.S. estate tax applies where a Canadian passes away with real estate worth over $60,000 USD with a worldwide estate value over $5,490,000 USD as of January 1, 2017. Please note that the tax rate is 40% on the U.S. property less a pro rata credit.
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 wasting your time now reading through reams of pages 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). We have developed the CBIT over time, fine tuned and recommend it often. If drafted correctly, the CBIT may eliminate the entire U.S. estate tax liability.
The CBIT won’t be for everyone. Nothing is perfect and every situation and family dynamic is different and needs to be analyzed carefully.
In the CBIT, there are two important parties: the trustee and the beneficiary (or beneficiaries).
We like this trust for clients who have children and want to leave their estate to the next generation. For those clients, their children 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 this is 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.
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.
You and your family can now enjoy the use of the property. 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. Additionally, it won’t matter whether the worldwide exemption amount goes up or down now or in the future.
Your children are protected in the trust from their personal creditors, if any, and should your son or daughter unfortunately experience divorce, the ex-spouse can’t access the property inside the CBIT because it won’t be considered a marital asset.
If you decide to buy a second U.S. property, it can go right into the CBIT.
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, are both living, and aren’t purchasing 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.
If purchasing and in need of a mortgage from a U.S. bank, 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 as a result of their overly lenient prior lending practices that resulted, in part, in the U.S. banking disaster.
Things become somewhat more complicated if you already purchased a property in your personal name and discover that you have a U.S. estate tax problem. There are additional steps to go through to submit your property into the CBIT. There is no question it needs to be very carefully structured. 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.
1 This article has appeared, in part, in David A. Altro’s book Owning U.S. Property the Canadian Way, Third Edition.
DAVID A. ALTRO B.A., LL.L., J.D., D.D.N., F. Pl., TEP, Florida Lawyer & Canadian Legal Advisor, is the managing partner of Altro Levy LLP, which he founded in 1988 with offices in Toronto, Montreal, Calgary, Vancouver, Florida, Arizona and California. David is the author of the books Owning U.S. Property the Canadian Way, Third Edition and Americans Living in Canada – Smile, The IRS is Watching You. Mr. Altro has been practicing law for over 30 years in Canada and the US, and his practice focuses on cross border tax, estate planning and real estate for high net worth individuals. He has written articles for numerous legal and industry publications.