Given our winter climate, many Canadians choose to be “Snowbirds” and buy a property to spend the winter in warmer climates in the United States (“US”).
Once that decision is made as to where and what, the structure of the purchase must be considered, so as not to run afoul of or be adversely impacted by various US and Canadian tax considerations during the ownership or sale of the property, or the death of an owner.
From a Canadian tax perspective, if the property is not used to generate rental income, and the money used to fund the purchase originates from the person buying the property, there are no Canadian tax consequences unless and until (a) the property owner sells the property at a profit or (b) passes away still owing the property and in both cases, the property has a fair market value at the time of death in excess of its tax cost. In either situation, the property owner will become liable to tax in Canada on the capital gain on the growth in value of the property.
US tax consequences are considerably more complex, and if not well planned, may result in significant tax liabilities that can be reduced or avoided with proper planning. A major difference between the Canadian and US tax systems is that in the US, “Estate Tax” is assessed on the gross value of the estate of the deceased individual and not based on increases in value. For non-residents of the US, the Estate Tax is only levied on US situs assets which includes property in the US (and also shares of US corporations). Accordingly, if a non-US resident person dies owning any real estate in the US and it is subject to Estate Tax, the tax is calculated based on the entire value of the real estate, regardless of whether or not it has appreciated in value.
This means that a Canadian who has never been a US taxpayer is still subject to US Estate Tax on certain assets, including real estate owned in the United States. Depending on values, the Estate Tax could be as high as 40% of the value of the real estate. There is no foreign tax credit for the Estate Tax that Canadians can use to reduce any Canadian taxes.
There is currently an exemption from US Estate Tax where a deceased’s worldwide assets do not exceed US$12,060,000 in value. Accordingly, when a Canadian dies holding worldwide assets under such amount, there will be no US Estate Tax imposed. The US exemption threshold is adjusted annually for inflation, but the current threshold is set to expire in 2026 at which time, if nothing else changes, the exemption threshold will be reduced to somewhere between US$6M to US$7M. It is important to note that as part of its tax reform, the Biden administration is looking to reduce this exemption to an even lower threshold and potentially sooner than 2026.
For many years, there was a fairly simple method of avoiding US Estate Tax on Snowbird property; namely, a Canadian corporation would hold title to the property. On the death of the Snowbird property’s owner, no US Estate Tax would result as the corporation continued to hold legal title to the property; the deceased only held shares in a Canadian corporation and held no US situs assets. For many years, the Canada Revenue Agency (“CRA”) had a policy that it would not take the position that the benefit of using the Snowbird property without paying market rent to the corporation was a taxable benefit. Unfortunately, a number of years ago, the CRA changed its policy such that the shareholders could no longer hold the Snowbird property through a Canadian corporation without becoming taxable on the shareholder benefit. This effectively put a stop to the Canadian corporation structure.
More recently, another popular method of limiting US Estate Tax was by way of a non-recourse mortgage. US Estate Tax is only levied on the value of real estate net of any non-recourse mortgage against the property. Where there was no mortgage from a conventional lender, a mortgage could be given from a funding spouse to the other spouse who would use the money to buy the property. Thus, the only exposure of the property to US Estate Tax would be to the extent it increased in value from the original acquisition price.
To avoid the application of the Canadian Attribution Rules (which could otherwise apply to certain loans and gifts between spouses, resulting in the income from the purchased property being taxed in the hands of the lending/gifting spouse), the non-recourse mortgage between spouses had to be interest bearing at the prescribed rate set by CRA, and the interest would have to be paid annually. The lending spouse would have to declare and pay tax in Canada on such interest earned on the mortgage. For the last few years, the prescribed rate has been 1%. If the Attribution Rules applied, any taxable income from the Snowbird property would be attributed not to the owner, but to the lending spouse from whom the funds originated. This would also mean any capital gain on the Snowbird property being sold would, in Canada, be taxed in the hands of the lending spouse and not the owning spouse. An additional problem is that there would be a mismatch with respect to the availability of the foreign tax credit: since there would also be capital gains tax in the US, which would normally generate a foreign tax credit against tax on the same gain in Canada, in the ordinary course the person disposing of the property would be able to use this credit against their Canadian tax liability. However, if the gain was taxable in the US in the hands of the owning spouse, but taxable in Canada in the hands of the lending spouse, there would be no ability to use the foreign tax credit generated from the US tax against the tax in Canada.
Given the appreciation on real estate in the southern US in the last few years, the interest that will be required using the non-recourse mortgage structure will be based on a significantly higher principal amount, and, given the recent hike in interest rates, the prescribed rate set by CRA will no doubt increase. This will cause a significant increase in the tax that will be payable on the interest received by the lending spouse on loans made after the increase.
While we are still using the non-recourse mortgage to limit US Estate Tax exposure, over the last couple of years we have started using other structures, including “Trusts”.
Where a family has an existing Trust with the resources to fund a purchase of a Snowbird property and there would be no attribution resulting from a loan by the Trust to the purchaser, we can still use the non-recourse mortgage structure but there would be no obligation to charge interest or any resulting tax on interest. This structure is available where the people that contributed the assets to the Trust in the first place are either no longer alive or no longer a resident of Canada for tax purposes.
There are also ways of using Canadian Trusts to acquire a Snowbird property such that the Snowbird property would not form part of the assets of the users for US Estate Tax exposure. Such Trusts would never allow the users to have any rights to the Snowbird property other than through the permission of a beneficiary of the Trust to use the property, and the ultimate ownership of the property would flow to other beneficiaries of the Trust; normally children or other lineal descendants. Any such structure has to be crafted carefully so as to make sure it denies ownership rights in the Snowbird Property by the funders of the Trust, and also avoids any Attribution Rule issues.
The other issue that has to be considered is the 21-year deemed disposition rule, requiring a Canadian Trust to pay capital gains tax every 21 years on increases in the value of its assets. To the extent the Snowbird property in such a Trust has appreciated to any significant degree and the Snowbird property is still held, it would have to be distributed to the beneficiaries, presumably children or other lineal descendants, before the 21st anniversary of the setup of the Trust.
A benefit, however, in such a structure is that it is in essence, a form of an estate freeze such that such a Snowbird property could remain in the family without triggering any capital gains taxes on the death of the original users. Such a structure should also avoid exposure to US and Canadian probate fees on the Snowbird property.
There are, of course, many other considerations involved in the purchase of Snowbird properties that are beyond the scope of this article. For more information or to address any questions, please reach out to the authors.
The authors would like to thank Joseph Owens from Dickinson Wright US for his input with respect to US Estate Tax. Aside from Dickinson Wright’s office in Toronto, the firm has 18 offices across the US including in Snowbird destinations like South Florida and Arizona.
This article originally appeared in the Jewish Foundation of Greater Toronto’s Giving Advice, Spring 2022 edition.
About the Authors:
Jennifer Leve (Partner, Toronto) focuses her practice primarily on personal and corporate tax planning, corporate reorganizations, wealth management, and trust and estate planning matters. She also represents clients in their dealings with the CRA. She provides a full range of domestic and cross-border tax advisory services to large corporate clients as well as investors and non-profit organizations. She can be reached at 416-777-4043 or firstname.lastname@example.org.
Alan Litwack (Partner, Toronto) focuses his practice on corporate/commercial matters, including mergers and acquisitions and securities and capital markets. Alan acts generally as counsel to public and private corporations on corporate and business matters and on shareholders disputes. He also advises professional services firms on tax and structural issues and owners entrepreneurs on succession planning. He can be reached at 416-646-3839 or email@example.com.