Cross Border Tax Issues: Canadians Buying US Real Estate Property

You’ve been looking at all those great values in US real estate and the premium value of the Canadian dollar. You’ve been thinking that now may be the time to buy before prices start to rise or all the bargains are scooped up. You’ve studied the decline in housing prices in the US Sun Belt and worry if this is the right time to buy.

Prices in Florida, Arizona, Nevada, and California are as much as 55% below their peak in 2007 (Wall Street Journal – July 7, 2011). Is now the best time to buy – who can possibly know for sure? According to the Wall Street Journal home prices in 27 major markets continued to fall in the first quarter of 2011. But the market will turn around soon won’t it? The simplistic answer to that question is it depends on your definition of “soon”.

The purpose of this article is to neither encourage nor discourage you to purchase a US residential property but to outline out some of the potential pitfalls and some of the procedures you need to be aware of – before you write any cheques.

Tax and Residential Status When Buying US Real Estate

The very first thing you should do is get expert advice before making any decisions. There are very different tax regulations in the US that could significantly affect you personally or your purchase decision. For instance, do you plan to spend lengthy periods of time in the US, do you plan to use it as a vacation home, do you plan to rent it to another party for all or part of the year, or will it be vacant for a significant period of time during the year. Know what you are getting into – before you’re in over your head. The international tax specialists at Aylett Grant will fully explain the tax and residential status implications that will affect you personally if you purchase a US residential property. If you go ahead with your purchase plan the Aylett Grant cross border tax specialists can look after your continuing tax matters to ensure your worry free enjoyment of your new property.

Financing a US residential property

A major roadblock you will encounter will be obtaining a mortgage on your intended purchase. Mortgage financing in the US is very tight due to new regulations enacted to ensure there will not be another mortgage meltdown. Also, you are a nonresident alien and most US lending institutions will not lend to you. The Harris Bank owned by the Bank of Montreal or the Centura Bank owned by the Royal Bank or the TD Bank may be your best possibility but you will still need a 30% down payment.  To obtain a US mortgage you will need to submit mortgage statements on your Canadian property, Canadian (and US if applicable) tax returns, employment information, asset statements (e.g. brokerage accounts), and complete bank statements with your application. Many advisors recommend that you arrange financing in Canada (re-mortgage your Canadian home, borrow against your Canadian assets, etc.) and pay cash for your property in the US. This will give you financial stability and eliminate any future exchange rate surprises. If you plan to pay cash for your new US home, make sure all the money is in a single account for at least 90 days before closing. When you show up in the US with a large amount of cash it will be reported and investigated under US money laundering and anti terrorist laws. You should allow at least 45 days for the money to clear and the sale to close to allow time for the title to be fully searched.

Location, Location, Location

As in any real estate purchase the location that you choose will significantly affect your enjoyment of the property, its current rentability, and its future saleability. Where you decide to buy, of course, is up to you but you should consider the following:

• Is the neighbourhood attractive?
• Is it safe?
• What are the employment rates in the area?
• Is it close to schools?
• What is the quality of the area schools? Do they provide a high standard of education?
• Is it convenient to shopping centers, food stores, etc.?
• Is it located in a disaster area (hurricanes, flood plain)?
• What are the taxes and insurance costs? Some states have enacted homestead laws providing that out-of-state property owners pay significantly higher property taxes than state residents occupying a prime residence.
• Are the neighbors friendly?
• Do you have any friends or acquaintances in the area? Knowing someone can make a difference in assimilating into the community. You may be required to provide a contact in case of an emergency; a friend could be a great help.
• Is it accessible to local amenities, transit, etc.?
• What about fire and police services?
• Are you able to fly to the location directly or do you need to make one or more connections? What is the cost of airfare? What is the travel time?
• If you plan to leave the property vacant for an extended period of time what security arrangements are available?
• If you plan to rent it what rental and maintenance agents are available?
• What is the vacancy rate in the area, what are the average rents?

Be sure to visit properties in person so you know exactly what you’re buying. A home inspection is an absolute requirement! Many foreclosed homes have been trashed or are in deplorable condition. If you intend to buy a fixer-upper get detailed estimates of repair costs and add a significant contingency fee before determining your offer.

Be Cautious

Now that you have decided where to purchase you need to be cautious of what you purchase.

• If you intend to purchase a condominium you need to be aware that the condo world can be tricky and murky, particularly in markets that have suffered from overbuilding and rampant speculation. Many condo associations are nearly bankrupt. You may be looking at a bargain price for the condo but you could still be shocked when you learn what the fees are if you are not cautious. Check the stability and financial statements of the condo association to ensure it is not sinking in a debt quagmire that you will have to partly assume. An ongoing cost of condominium ownership is the monthly administration and maintenance fee. You will need to thoroughly review the condominium agreement and check the historical fees that have been charged to determine if the fees are reasonable and affordable.
• If you are purchasing a single residential property that is under construction or recently completed you should be aware that that the housing crisis has resulted in the bankruptcy or near bankruptcy of many builders and general contractors. Many purchasers have learned to their sorrow that the builder has disappeared before he completed the home or that it has been plastered by builder’s liens and other encumbrances. If you are contemplating purchasing such a property get professional help to ensure that you withhold sufficient funds to complete the residence and satisfy any liens.

 Ownership medium

Before you take the next step you need to understand that various ownership mediums that are available to you. You can purchase the property personally, set up a limited liability company or partnership, or set up a cross border trust to hold the title to the property. Each may have a particular advantage depending on an individual’s particular circumstance. For instance, a company’s shares can be sold or transferred without actually selling the property and may be subject to a different taxation policy than a real estate sale. A cross border trust may facilitate the settlement of your estate if you intend to pass the property on to your heirs. In fact, your estate plan should be an important factor in your decision to set up the appropriate ownership vehicle for you. Before you make your final decision make sure that you understand how the various structures are taxed in both the United States and Canada
The tax specialists at Aylett Grant can review your particular circumstances and advise you on the best ownership vehicle for your individual intentions and circumstances. We will brief you on the various ownership structures and the tax implications of each as it applies to your individual circumstances so that you can make a fully informed decision on the best way to hold the title to a US property.

Offer to Purchase

You have found the ideal property, decided on the appropriate ownership medium, and you intend to submit an offer. This is a cautionary note: if you think your ideal property just needs a little fixing up that you can easily do yourself you should be aware that you can be deemed to be conducting a business in the United States and violating US immigration laws. You should factor into your offer to purchase the cost of a US contractor completing all necessary renovations and repairs.
Before you submit your offer you are strongly advised to consult an experience lawyer that fully understands the ramifications of cross border real estate transactions. A lawyer can guide you and advise you on what actions you must take including the appropriate deposit and how to protect it in case the offer is not accepted or the seller is unable to deliver clear title. A lawyer can fully explain the legal ramifications of the various legal forms that you will be required to sign.
Submitting your offer is, metaphorically speaking, the point of no return. Mistakes at this point will be expensive and difficult to correct. Now is the time consult the professionals but you should be as careful selecting your lawyer and other agents as you were selecting the property that you intend to buy. You should be aware of the conduct of some agents, brokers, and appraisers leading up to the mortgage meltdown. You will need to carefully consider the following:

• Do you have the right lawyer? Is he or she an expert in cross border real estate transactions?
• Do you have the right real estate agent? Who recommended him or her? Is he or she competent to assist you to submit the correct offer?
• Have you obtained a current appraisal from a competent appraiser?
• Do you have the home inspection report from a competent inspector?
• Do you have repair estimates from a competent contractor?
• Check and double-check title.
• There have been many cases of purchasers making a down payment on a property only to discover the seller did not have clear title.
• Some banks in the US are under investigation for falsifying foreclosure documents and cannot deliver clear titles.
• Make sure that the title search covers all previous owners of the property from when it was first built.
• Title insurance is a must but it is not foolproof – deal only with well-known, reputable companies.
• If you have sought the services of a mortgage broker to assist in obtaining financing for you new property is he licensed? Does he have a good reputation? Remember the mortgage meltdown!
• Have you obtained the services of a reliable escrow agent? Who recommended him?
• When you purchase a home in the United States there is a process known as “escrow.”  In Canada a lawyer usually handles this process through his law firm’s trust account.
• During escrow the seller transfers the title to an escrow company or agent.
• The purchaser transfers the purchase price including any mortgage proceeds to the escrow agent. To avoid unnecessary delays you should seek advise as to the most efficient method of transferring the required proceeds to the escrow account.
• Once all of the conditions of the sale are met the purchaser will take possession of the property and the seller will receive the funds.

 After the Purchase

Congratulations – you are now the proud owner of a new US residence. There are just a few more things you must do to protect yourself and your new property:

• If you have not already done so during your mortgage approval get home insurance now. Obtaining insurance in the US may not be as simple as it is in Canada. Some homeowners have required four different policies from as many different insurance companies to adequately protect their residences. Make sure that you are covered for the following:
  1. Liability – remember you have now entered a very litigious society.
  2. Fire
  3. Theft
  4. Disaster Insurance (flood, water damage, storm etc.)
• If you intend to leave your new residence unoccupied for any length of time make sure that your insurance includes the necessary coverage. Your insurance company will require a frequent inspection by an acceptable person so you will need to arrange for this. If you leave your house unoccupied for an extended period you could void an ordinary insurance policy.
• Carefully read your insurance policies. Check the exclusions to make sure it meets your requirements. It is not unusual for US policies to have a 25% deductibility clause and a host of exclusions.
• Change your locks. Just assume that all the bad guys have keys.
• Arrange for necessary repairs. If you have already received an estimate from a contractor before you submitted your offer now is the time to get two other estimates and make your final decision. You need to be aware that if you have purchased it for investment purposed you are not allowed under US immigration law to even lift a paint brush. A violation could result in your deportation from the US and being banned from returning.
• If you intend to rent the property you should obtain the services of a reputable rental agent. If you intend to look after the property yourself (not advisable for most people) you will need to find a reliable tenant. You should avoid tenants that advertise on sites like Craig’s List and carefully check all references. Your real estate agent might be able to advise and assist you.

 Consult a Tax Professional

If you have not yet received expert tax advise now is the time to do it particularly if you intend to rent your new property for any part of a calendar year. If you have decided to rent your property you can avoid the 30% withholding tax by electing to pay US income tax on net rental profits.

The cross border tax specialists at Aylett Grant can assist you with all your cross border tax matters to ensure that you do not run into unexpected tax and residency problems. The penalties that the IRS can apply are severe and punitive. You can be assessed a $500 penalty for a careless mistake or fined $10,000 for failing to file any form the IRS requires from nonresident aliens (that would be you). Ignorance is not an excuse readily accepted by the IRS.

In the United States the IRS does not act as a tax agent for the individual states as the CRA does in Canada. Many states have their own tax laws that may be similar to or parallel the IRS filing requirements. However, state laws vary from state to state and specific advice may be required for your new state.

AG TAX LLP Can Help

If you have any other tax-related queries, and/or need assistance with tax planning/filing please contact AG Tax. Our tax professionals are highly-experienced with US and Canadian tax laws and can provide you the right guidance to handle your tax situation.

Aylett Grant Tax LLP is a full service accounting firm with a dedicated team of experts, who are highly-qualified and experienced in handling situations related to US, Canada and other international tax laws.

We can assist with:

• Canadian Personal and corporate tax returns
• Cross Border Taxation and Business Planning
• Personal and Corporate Taxation
• Disclosure of Foreign Assets and other information filings
• Retirement planning
• Estate Planning, Inheritance tax advice

To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:

• 416-238-5920 (Greater Toronto Area, ON)
• 604-538-8735 (Greater Vancouver Area, BC)
• 780-702-2732 (Greater Edmonton Area, AB)

 

Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.