How to own U.S. rental property

If you’re like a lot of Canadians who are buying U.S. property while prices are affordable, you might benefit from some pointers on the best ownership structure.

Any structure strategy should consider issues such as probate, incapacity and U.S. estate tax. And anyone owning rental properties has two additional concerns: creditor protection and maximizing profits through tax planning.

Partnerships are a good way to protect owners of U.S. rental properties. But, since partnerships must have a profit motive, they’re not the right choice for personal-use property.

The most common partnership structures for owning U.S. real estate are:

1. Limited Partnerships, which have two types of partners:

• General Partners: Unlimited liability for partnership debts
• Limited Partners: Liable only for partnership debts up to the amount of their capital investment in the partnership

If an LP is used to hold U.S. real estate, it’s best to create a corporation as the general partner. Clients can act as limited partners. The general partner typically invests a small amount in the partnership, while the limited partners invest the remaining amount.

Some of the benefits of holding U.S. rental property in an Limited Partnership:

• U.S. probate – Partnership interests are intangible assets, so they pass to a limited partner’s heirs upon death without probate.
• Incapacity and guardianship – Properly drafted, LPs can avoid guardianship proceedings if a limited partner becomes incapacitated; the limited partner acts by way of the general partner, which is a corporation, and corporations can’t become incapacitated.
• U.S. estate tax – LPs may avoid U.S. estate tax upon the death of a limited partner. It’s not yet clear whether the IRS has authority to tax Canadian residents on partnership interests as if they’re U.S. situated assets for U.S. estate tax purposes. Thanks to its look-through rule, IRS may levy estate tax on a limited partner upon death.
• Creditor protection – Limited partners receive creditor protection. If a third party or tenant successfully sues the LP as owner of the rental property, then only the general partner will be liable for the partnership’s debts.
• Tax treatment of rental income – LPs are classified as flow-through entities in both the U.S. and Canada. U.S. tax rules require partnerships to withhold tax on income to foreign partners at the highest marginal rate. Since that rate’s applied regardless of the partners’ actual tax bracket, it’s likely too much tax will be withheld. So, partners can request a refund when they file annual income tax returns.
• Capital gains tax treatment – When the U.S. property is sold, clients get a lower capital gains tax rate as limited partners compared to owning the property in a corporation

2. Limited Liability Partnership (LLP)

In LLPs, each partner has limited personal liability for the partnership’s debts. This eliminates the need to incorporate a company that acts as the general partner. LLPs are therefore less expensive to implement and maintain than LPs.

They also provide creditor protection if the partners are non-residents of the U.S. (For instance, two spouses who are Canadian citizens and residents.)

But when one partner’s spouse passes away, the structure ends. Moreover, upon the first partner spouse’s death, state regulators may implement probate proceedings to pass the partnership interest to the deceased spouse’s heirs.

LLPs also don’t protect clients from U.S. estate tax.

For these reasons, the LLP isn’t ideal for holding U.S. rental property.

3. Limited Liability Limited Partnership (LLLP)

The LLLP is a fairly new structure and is only recognized in certain states. There is no Canadian equivalent.

It’s similar to an LP, having both general and limited partners. But if the LLLP chooses, its general partners’ liability for partnership debts will be limited instead of unlimited.

For Americans, the LLLP is great for holding rental properties. It provides creditor protection by limiting liability of its general partners, while also acting as a flow-through entity, allowing partners to be taxed at lower personal income tax rates.

However, it’s still unclear what the tax consequences are for Canadian clients who hold U.S. rental properties in LLLPs. As yet, CRA hasn’t yet indicated whether it will view LLLPs as corporations or partnerships, making the potential for double taxation of rental income earned from U.S. property held in an LLLP clearly problematic for Canadian residents.

Recommendation: LP

The LP structure remains the soundest solution for Canadian clients who own U.S. rental properties.

David A. Altro is a Florida attorney, Canadian legal advisor and the managing partner at Altro Levy.

David A. Altro