What's up dock: Tax & estate planning for your vacation property
During the summer months, many families spend time together away from the hustle and bustle of daily living and retreat to one of the "four C's" of summer: the cabin, condo, chalet or cottage. Unbeknownst to you, however, is that lurking under the surface of your idyllic retreat may be a host of tax and estate planning issues that, if not tackled early on, could not only cost you (or your heirs) a lot of cash, but in extreme cases, could force the sale of the recreational property that may have been in your family for generations.
With some professional advice and some advance planning, however, you may be able to mitigate some of these potential problems.
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U.S. VACATION PROPERTIES
In Canada, upon death, there is a deemed disposition of all your property at fair market value. Any capital gains tax resulting from accrued appreciation (from the date of purchase to the date of death) is payable on your final return.
Not so in the U.S. where citizens and green card holders are taxed on the fair market value of all property owned on the date of death under the "estate tax" regime.
Even if you're not a U.S. citizen, the U.S. estate tax could apply to you if you own "U.S. situs property" upon death, which includes U.S. real estate.
Estate tax rates for 2009 begin at 18%, and quickly rise to 45% for U.S. situs property above US$1.5-million.
There is, however, an exemption available for the first US$3.5-million (2009) of your estate, but it is only available to U.S. citizens. Canadian residents who are not U.S. citizens are entitled to a pro-rated credit under the Canada-U.S. tax treaty which is equal to the US$3.5-million exemption multiplied by the ratio of U.S. situs property to your worldwide estate. Thus, if your worldwide estate, including your principal residence, is under US$3.5-million, you don't need to worry about U.S. estate tax on your vacation property.
Note that at the time of writing, the future of the entire U.S. estate tax system, rates and exemptions for years after 2009 is uncertain. Close monitoring of U.S. developments in the future will therefore be critical to ensure your planning is up to date.
If, however, your worldwide estate is worth more than US$3.5-million, it's a good idea to do some advance planning.
One strategy to help fund a potential US estate tax liability upon death is to purchase life insurance (see above) to cover any tax liability upon death. Keep in mind that the value of such life insurance will be included in the value of your worldwide estate.
Another solution is using "non-recourse" debt, which can reduce the value of the property for U.S. estate tax purposes. This is a mortgage in which the lender only has the ability to collect amounts owing from the sale of the property, as opposed to the general assets of the borrower.
Before 2005, U.S. real estate was often purchased through a Canadian corporation to avoid U.S. estate tax upon death, but as a result of a change in Canada Revenue Agency administrative policy, effective for 2005 and later years, a taxable shareholder benefit is now imposed upon the corporation's owner, making this strategy less attractive. (Pre-existing structures were grandfathered.)
Most cross-border tax professionals today are recommending purchasing the U.S. property through a properly established Canadian trust to avoid U.S. estate tax. The planning surrounding this strategy is beyond the scope of this report and professional Canadian and U.S. legal and tax advice should be sought before pursuing this strategy.
As with all planning strategies, you should seek the advice of a qualified financial advisor or tax advisor to discuss planning opportunities for recreational properties.
Jamie Golombek, CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Private Wealth Management in Toronto. As a member of the CIBC Retail Markets team, Jamie works closely with advisors from CIBC Private Wealth Management, Wood Gundy, Imperial Service and other partners to support their high net worth clients and deliver integrated financial planning and comprehensive advisory solutions. Jamie writes a weekly column called "Tax Expert" in the National Post, which is also syndicated across various CanWest newspapers in Canada. In his spare time, Jamie teaches an MBA course in personal finance at the Schulich School of Business at York University in Toronto.