Snowbird property holding mistake

When advising Canadian residents regarding the acquisition of U.S. real estate, a question that sometimes arises is: “should the property be held through a corporation?”

As discussed on page 28 of the Summer 2011 issue of Canadian Capital, holding U.S. real estate through a corporation means when the Canadian shareholder dies, he or she owns shares of the corporation (which would, arguably, not be subject to U.S. estate tax) rather than U.S. real estate (which would be subject to U.S. estate tax).

As a result, it was relatively common for Canadian individuals to acquire U.S. recreational properties through a Canadian corporation (referred to as a “single purpose corporation”).

However, here’s why this is no longer a tax-effective strategy.

Read: Does your client have U.S. tax risk?

Shareholder Benefit Issue

Under the Canadian tax rules, a shareholder is deemed to receive a taxable benefit in respect of the personal use of any assets of the corporation. For example, if a corporation owns U.S. real estate, and a shareholder uses the real estate without paying rent, then the value of the use of the real estate (i.e., the rental benefit) must be included in the shareholder’s income for Canadian tax purposes. Prior to 2005, Revenue Canada’s administrative policy was to not apply a taxable benefit where the property was held through a single purpose corporation. However, it has reversed this policy (and will thus impose taxable shareholder benefits) for any properties acquired after December 31, 2004.

Corporate Tax Rates

Holding U.S. real estate through a corporation may significantly increase the amount of capital gains tax payable on a future sale. In particular, the U.S. federal tax rate applicable to long-term capital gains (where the property has been held at least one year) is typically 35% for a corporation and 15% for an individual (or trust).

Read: Incorporation tax benefits

If an Ontario Resident Holds U.S. Real Estate…

A foreign tax credit is generally available in Canada for any U.S. taxes paid. Accordingly, tax is effectively payable at the higher of the Canadian or U.S. rate. As a result, if U.S. real estate is held by an Ontario resident individual in the top tax bracket, then the combined Canada/U.S. capital gains rate on a future sale would be approximately 23.2%. Specifically, the capital gain would be taxed at 15% in the U.S. and 23.2% in Canada). However, a foreign tax credit would be available in Canada for the 15% U.S. tax. As a result, the effective tax rate in Canada would be reduced to 8.2% and the combined tax rate would be 23.2%.

Read: U.S. estate tax for Canadians

If a Corporation Holds U.S. Real Estate…

If the property is held through a corporation, then the combined Canadian and U.S. capital gains rate applicable to the corporation would be approximately 35%. So the capital gain would be taxed at 35% in the U.S. and 23.3% in Canada (being the capital gains tax rate for a corporation resident in Ontario. A foreign tax credit would be available in Canada for the 35% U.S. tax, which means the effective tax rate in Canada would be nil and the combined tax rate would be 35%. Further, following the sale, the sale proceeds would be held within the corporation. If the Canadian shareholder wanted to distribute those proceeds personally, there would be additional shareholder level tax on the distribution.

Paul Gibney and Brent Pidborochynski are tax lawyers at Thorsteinssons LLP.

This article originally appeared in Canadian Capital.