LLC spells trouble for Canadians with U.S. property

For Canadians with U.S. property, a limited liability company (LLC) can cause major headaches due to the U.S.’s foreign reporting requirements. Though Canadians can personally avoid double taxation thanks to the Canada-U.S. Tax Treaty, CRA does not recognize a LLC as a flow-through entity (an entity in which income generated is attributable to its owner). This results in a mismatch in foreign tax credits.

Instead, CRA sees the LLC as a corporation — a separate taxpayer, which means double taxation that can be as high as 80% between both countries. So owning U.S. property in a LLC is usually not the right strategy for Canadians.

Further, if a Canadian corporation, instead of an individual, owns the LLC, additional problems arise at tax time. Under U.S. tax law, the LLC can be designated a disregarded entity. This means the Canadian corporation is a non-U.S. corporation, and it is subject to branch profit tax. Typically this is set at 30%, but the Canada-U.S. Tax Treaty reduces that rate to 5%. On top of this tax, the Canadian corporation will have to pay dividend tax on any amount it distributes to Canadian shareholders. So even when using a Canadian corporation, the LLC is still not the best way for you to invest in U.S. property.

Some good news

Instead of owning property in a LLC, you can set up a U.S. Limited Partnership (USLP) and take title directly.

A USLP is a flow-through structure recognized on both sides of the border, so it lets you benefit from foreign tax credits and avoid double taxation. A USLP is composed of:

• a general partner, which can be a LLC since it will receive only 0.5% of the income generated in the USLP but will absorb 100% of any potential liability; and
• one or more limited partners, who would receive 99.5% of the income but provide liability protection.

Most states and provinces allow limited partners to be directors of the corporate general partner without losing liability protection. Further, the only assets exposed to creditor claims are the ones owned by the USLP, leaving your personal assets out of reach. So the limited partners of the USLP benefit from creditor protection while receiving 99.5% of the income, and being taxed at lower rates.

Another advantage of the USLP: when partnership documents are drafted properly, you can avoid costly and time-consuming incapacity and probate procedures. As an intangible asset, partnership interests should pass with the partner’s domestic estate in Canada, irrespective of where the partnership owns assets.

And if you own assets in the U.S. and have worldwide estate values over $5.43 million, U.S. estate tax exposure should also be considered.

This tax is based on the fair market value of all U.S. assets owned at the time of death. It can climb up to 40%, depending on the value of the U.S. asset and the value of the worldwide estate. Note this is not a capital gains tax — it’s a value tax.

A well-thought-out structure can help avoid several problems. So consult with a cross-border expert to help set up a structure tailored to your goals.