PUBLISHED: Feb 5, 2018
UPDATED: April 2nd, 2020
If you are a Canadian who owns US real estate, whether for personal use or investment purposes or both, one of the key issues is transferring the property to your heirs on death. Unless you have the right ownership structure, the property will have to go through probate in order to transferred to your heirs. If you are a Canadian who already owns US real estate or is thinking of acquiring US real estate, this article explains the concept of probate as it applies to you and how you can plan against it.
Probate is the legal procedure by which a court verifies a last will and testament and orders its execution. During the proceedings, the property is “frozen” in that it cannot be rented out, sold or otherwise alienated. This restriction applies whether you own personal US real estate or investment US real estate.
These proceedings are public in many States and your will is deposited with the court. This means that anyone can know what US assets you own at the time of your death.
Although Canadian wills are valid in the United States, they are nevertheless subject to probate in the United States. This applies even to Quebec notarial wills which are exempt from probate under Quebec law.
Florida is one of the most popular US travel destinations for Canadians, and many Canadians own vacation homes in that State. Probate proceedings in Florida are especially long and costly. They can last between eight (8) and twelve (12) months, and the legal fees can be between three percent (3%) and five percent (5%) of the fair market value of the property located in Florida determined at the time of death of the decedent.
How to Avoid Probate?
There are numerous ways to avoid probate on US real estate. They all work well for Americans, but most do not work so well for Canadians. We will look at the most common ones.
1. Joint Tenants
Two or more person(s) who purchase real estate together acquire it as “joint tenants with right of survivorship” or, if in the case of a married couple, as a “tenancy by the entirety”. These two forms of ownership are nearly identical, the only difference being that tenancy by the entirety is reserved to married couples. Both of them avoid probate. Upon the death of one of the owners, his or her interest in the property is transferred to the remaining owner(s) free of probate. In this aspect, these forms of ownership are great. However, probate will need to be undertaken upon the last owner’s death or if all the owners die at the same time.
Some Canadians who hear of probate in the United States are advised by friends or even by US lawyers to add their children on title to their US vacation home as joint tenants with right of survivorship to postpone probate. This should be avoided because the transfer is potentially subject to multiple layers of tax in the United States and Canada.
In the United States, the transfer will be a taxable gift in the United States and can be taxed at up to 40% of the value of the gift. This tax on gifts is called “US Gift Tax”. The worst part of US Gift Tax is that the donor, the person who made the gift, foots the tax bill. Americans do not have not to worry about gift tax because they are entitled to a lifetime gift tax exemption. Canadians are limited to an annual US Gift Tax exemptions which are often well below the value of gifts of US real estate.
In addition to US Gift Tax, where a Canadian gifts US real estate which has accrued gains, the Canada Revenue Agency (CRA) will deem the Canadian to have disposed of the property and will tax him or her on the deemed capital gain. This capital gains tax cannot be offset or reduced by the US Gift Tax. Also, since the CRA taxes in Canadian dollars, the value of the gift will be converted from US dollars (USD) to Canadian dollars (CAD). If the donor acquired the gifted US real property when the Canadian dollar was at parity with the US dollar and the Canadian dollar is worth $0.70 USD, then there will be a currency gain, which is also taxable.
Verdict: By adding family members on title to your US vacation home to avoid probate, as a Canadian, you can be subject to up to three (3) levels of tax in the United States and Canada. There are better ways for avoid probate on US real estate.
2. Life Estate Deeds
Other Canadians sign life estate deeds for their US vacation properties. A life estate deed transfers title to a property to remaindermen and gives the transferor (the previous owner) a life estate, which is the right to use the property for the duration of his or her life. The transferor becomes a “life tenant” and upon his or her death, the life estate is extinguished. Some Canadians name their children as remaindermen of their US vacation homes and retain a life estate. This deed allows you to transfer your US vacation home to your children without going through probate. Some States such as Florida recognize “enhanced life estate deeds”, which are also called “Lady Bird Deeds”, which differ from traditional life estate deeds.
Life estate deeds have the same issues as adding your children as joint tenants after purchasing a property: US Gift Tax. The transfer made pursuant to a life estate deed is subject to US Gift Tax. If you sign a life estate deed over your US vacation home naming your children as remaindermen, you will have to pay US Gift Tax on the transfer.
Creating a life estate in your favour with other persons (e.g. family members) becoming a remainderman is also deemed by the CRA to be a disposition of the property. You will be taxed on any accrued gains on the property as well as any currency gain if the US dollar (USD) increased in value vis-à-vis the Canadian dollar (CAD) between the moment you acquired the property and the moment you create a life estate in your favour.
Verdict: Life estate deeds for Canadians owning US real estate have the same US and Canadian tax problems. This is far from the best way for a Canadian to avoid probate in the United States.
3. Canadian Corporations
Some Canadians own their US real estate through a Canadian corporation. Since a corporation does not die, US real estate held through the corporation will never be subject to probate. It also offers the advantage of limiting your liability to the corporation’s assets. This is key in the event liability is triggered in respect to US real estate: the creditor or tenant can only claim the corporation’s assets, not those of the shareholder. However, there are a few problems with this structure.
If you are a shareholder of the Canadian corporation and you personally use US real estate held by the corporation, the CRA will deem your personal use of the property to be a “shareholder benefit” and will impose tax on this benefit. There are strategies for mitigating this benefit, but they are not always desirable.
In addition, if you own investment US real estate through a Canadian corporation and you are the direct shareholder of the corporation, you will be subject to the punitive Canadian Foreign Accrual Property Income (FAPI) rules on income and capital gains earned from the US real estate.
Verdict: Being a direct shareholder of a Canadian corporation which holds US real estate guards against probate, but has a number of other problems.
4. Limited Liability Company
A Limited Liability Company (“LLC”) is a novel business structure that was pioneered in the United States, but it has no equivalent in Canada. Like a corporation, the liability of the member of an LLC (akin to a shareholder of a corporation) is limited. Unlike a corporation, under US tax law, an LLC is not a taxpayer. Instead, it is a disregarded entity, which means that all income from the property (if any) is taxed solely in the hands of the owner of the LLC.
Canadians should avoid LLCs because they trigger double taxation except in certain circumstances.Since Canada does not have LLCs, the CRA views LLCs as corporations. If you sell a US property held through a LLC, you will suffer double taxation because the US Internal Revenue Service (“IRS”) will tax you personally on the sale proceeds, the CRA will tax the LLC on the sale proceeds, and you will not be able to claim a foreign tax credit in Canada for tax paid in the United States.
Verdict: Owning US real estate through an LLC exposes Canadians to double taxation.
5. Revocable or Living Trusts
A US revocable trust (also called “living trust”) is often suggested as a structure for owning US real estate. Like any trust, it has a grantor (also called a “settlor”), a trustee, and a beneficiary. The grantor creates the trust and donates initial capital to the trust. The trustee administers the trust property for the benefit of the beneficiary. The last party, the beneficiary, is the individual who enjoys the beneficial use of the trust property.
In the United States, it is possible for the same person to be grantor, trustee and beneficiary at the same time provided (i) future beneficiaries are named and (ii) there is an independent trustee who is acting alongside him or her. This allows the person to fully control the property. Through the trust instrument, you can designate future beneficiaries who shall receive the property upon your death.
Property held in a revocable trust is not subject to probate as the trust does not “die”. The future beneficiaries shall receive the property upon your death free of probate.
However, US revocable trusts may trigger double taxation for Canadians. They are treated as disregarded entities by the IRS, but the CRA generally views trusts as separate taxpayers. If a Canadian sells a US vacation home held through a revocable trust, the IRS will tax him or her directly on the sale and the CRA will tax the trust. However, double taxation may be avoided depending on who are the grantor, the trustee(s) and the beneficiaries. Due to the CRA rules regarding the treatment of trusts, we do not recommend that Canadians own US real estate through a standard US revocable trust.
Verdict: Ownership of US real estate through a standard US revocable trust or living trust exposes Canadians to double taxation.
6. Cross Border Trust
The Cross Border Trust (“CBT”) operates like a US revocable trust. Any US real estate held through a CBT can be transferred to the future beneficiaries of the CBT free of probate.
The CBT also receives the same US tax treatment as a US revocable trust in that it is treated as a disregarded entity: the beneficiary of the CBT is directly taxed on the sale of property held through the CBT. However, unlike a US revocable trust, a CBT is also disregarded by the CRA. The beneficiary is therefore also solely taxed on the sale of property held through a CBT. This avoids the double taxation problem that afflict some Canadians who own US real estate through US revocable trusts because they can claim a foreign tax credit in Canada for the tax paid in the United States on the sale of US real estate held through a CBT.
Moreover, a transfer of property into a CBT is a tax-free event. No US Gift Tax nor any Canadian tax will be owed because the IRS does not view it as a taxable gift and the CRA does not deem you to have disposed of the property.
Verdict: For Canadians owning US real estate, a CBT is a vehicle that allows for the transfer of the property free from probate without exposure to US Gift Tax, Canadian capital gains tax or double taxation that arise from other common ownership structures.
Probate is a key estate planning issue for Canadians who own US real estate because it is a certainty on death unless you have the right structure. Many probate avoidance solutions that work for Americans do not work well for Canadians. If you own US real estate or are contemplating purchasing US real estate, we strongly recommend that you consult one of our qualified cross border tax and estate planning attorneys for guidance.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.