Buying Real Estate in the U.S. … What About Your Canadian Plan?
There is no denying that the United States continues to be a hot spot for many Canadians, and although the housing market crash has begun to recover, prices are still nowhere near where they once were. This coupled with the strength of our Canadian dollar means one thing; it’s a wonderful time to be Canadian. Although, the Canuck in me would say that it is always a great time to be Canadian, now is especially good. That aside, being a Canadian investing in the US real estate market comes with many considerations and decisions.
If you want to understand the issues of owning real estate in the US, or the various ways in which you could consider taking title of their property, then I am sorry to inform you that the rest of this article isn’t going to address those issues. These topics can be found by clicking the this link. However, before you stop reading there are other important things to address when making a US purchase that actually have nothing to do with the US at all, and that is your domestic estate plan.
Too often clients come to our office ready to discuss their US tax and estate planning without having domestic wills, or even considering having them done. These documents don’t negate the need for proper planning when purchasing in the US any more then having a proper plan for your US purchase negate the need for domestic wills. What many people tend to not understand is that a good tax and estate plan brings both these facets together. In fact, even when clients do have domestic wills in place having the ability to look and potentially modify them may provide major tax and estate savings upon death.
Typically when a plan is being formulated for a US purchase and a trust is being used, your domestic will is no longer applicable in the US to deal with the distribution of the US asset upon death. However, how your domestic will is structured could still have some major influences on the US side.
Let us take the topic of US estate tax, but first we must understand on a general basis how it works for Canadians. When you pass away, although you are a Canadian citizen and resident you may still have a US estate tax exposure. The US estate tax is a death tax that is based on the fair market value of your US assets on your date of death. However, in order to determine whether you would have such a tax is based on a two-part test. Part one asks, what the value of your US assets was on your date of death. If your US assets were under $60,000 then that is the end of the test and no tax is due. This however is unrealistic for most people purchasing a property in the US. Should your US assets be over $60,000 on your date of death, that doesn’t necessarily mean there is any tax, it simply means that we now need to look at the second part of the test. Part two asks, what the value of your worldwide assets was and everything counts, including life insurance. Today, the current worldwide exemption is $5,250,000. This means that if you are over that exempted amount you will have a US estate tax liability when you pass away with a graduated tax rate of up to 40%. Let us be clear, you are not taxed on your worldwide assets but simply on the US assets. Your worldwide is used to determine if there is tax, and if so at what tax rate. If you are curious to know your US estate tax exposure please try our easy to use calculator.
Now that we understand the US estate tax, we can go back to our discussion on domestic wills. Given that your worldwide estate is directly linked to the US estate tax, how you leave your assets to your spouse, children or other beneficiaries becomes extremely important. More often then not I see very basic domestic wills that state husband leaves everything to wife, wife leaves everything to husband and if spouse has predeceased everything goes to the children. Unfortunately this provides no planning whatsoever for your loved ones. Take a married couple that has a combined worldwide estate of $10,000,000, each spouse having 50% and US assets worth $1,000,000. Based on these numbers it is clear that under today’s worldwide exemption of $5,250,000 there would be no US estate tax upon the passing of the first spouse, as their respective shares are under the exempted limits. However, should their wills simply state that they leave everything to each other, the surviving spouse will now have a worldwide estate worth the full $10,000,000, opening the door for the IRS to tax the surviving spouse upon their death on the $1,000,000 US asset.
This could all be avoided with the right plan being implemented in your domestic wills. Instead of leaving everything to your spouse outright, we can instead leave all your assets to them inside of a spousal trust. Provided that the spousal trust is structured the correct way, those assets that you leave your spouse will remain outside of their estate. Therefore, in our example, had spousal trusts been utilized in their wills, the surviving spouse would have been able to keep the property without any worry of US estate tax exposure, as upon their death they would only have been deemed to have $5,000,000 worldwide assets, not the full $10,000,000. The same concept would apply to your children. Additional planning can be done so that instead of leaving your assets directly in their name after you pass away, specialized trusts can be created which would achieve the same outcome should they decide to keep the US asset.
Additionally these trusts, whether we are talking about the spousal trust or the trusts for your children, provide even further advantages for your beneficiaries long after you are gone. For starters it would ensure that the assets being left are protected from creditors, which includes divorcing spouses. They would also allow your beneficiaries to benefit from income splitting. This is a tax concept whereby the income generated in the trusts are taxed at their own graduated rates as opposed to your beneficiaries high personal tax rate. The end result being more after tax money in their pocket.
The basic point that needs to be retained is that a solid domestic estate plan is equally important, as your worldwide assets are a key factor in determining whether there would be any US estate tax. It is also important to note that the US estate tax rules keep changing. Although the worldwide exemption is currently at $5,250,000, we cannot predict what the exemption will be down the road. This is why looking at the domestic plan is important. Even if your worldwide is well under the $5,250,000, creating a plan domestically can help reduce any future exposure should the exempted limits change, putting you in a US estate taxable position.
The use of spousal trusts and trusts for your children is just the start. The overall concept of keeping worldwide assets as low as possible can be achieved in many different ways. Another example would be to use what is called an Irrevocable Life Insurance Trust to keep life insurance proceeds outside of your estate. As we saw, the US will include any life insurance you may have as part of the value of your worldwide estate. For many this could be quite significant, especially if it is being used as part of a tax plan. This is truthfully a full topic on its own but understand that focusing in and re-evaluating your domestic estate planning is a crucial step in owning US assets.