For those Canadian investors who were hoping to bequeath U.S. properties to loved ones, that legacy could come back to haunt the survivors.
“The U.S. estate tax is imposed on the value
of the assets owned by a decedent at the time of his or her death,” says Robert E. Ward, J.D., LL.M., of Ward Chisholm P.C. “In contrast, Canada generally treats death as a disposition of the decedent’s assets, triggering recognition of the untaxed gain inherent in those assets.”
Consequently, cost basis (that is, the amount paid for the asset) is important in computing the Canadian tax on deemed dispositions at death. In contrast, the decedent’s cost basis is ignored in computing the U.S. estate tax.
“The entire fair market value of the asset is subject to U.S. estate taxation at death,” he says.
The manner in which estate tax is computed in the U.S., and the deductions that are available, also differ from the Canadian model.
“After determining the nature, extent, and situs of the decedent’s assets,” says Ward, whose background of expertise includes tax law, business planning, estate planning, international taxation and tax planning and foreign trusts, “the total fair market value of the decedent’s U.S. situs assets is reduced by certain deductions to arrive at a net taxable estate on which the U.S. estate tax is assessed.”
For a Canadian investor’s gross estate, for U.S. estate tax purposes, it will be reduced by the following expenses and bequests:
1) estate administration expenses (including professional fees, court fees, and executor’s fees);
2) the decedent’s debts;
3) bequests to charities; and
4) bequests to a spouse.
However, all estate administration expenses and debts are not deductible in computing the taxable estate.
“Although estate administration expenses for both U.S. situs and non-U.S. situs assets are taken into account, as well as all the decedent’s debts, only a portion of these obligations is deductible,” says Ward. “Estate administration expenses and debts are allocated between U.S. situs assets and non-U.S. situs assets. The allocation is made on the basis of the ratio of the U.S. situs assets to worldwide assets.”
As a result, an asset with no equity – because the amount of debt which encumbers the asset equals or exceeds its value – may nonetheless be subject to U.S. estate taxation depending on the other assets the decedent owned.
This unfortunate result may be avoided to the extent U.S. situs assets are encumbered by non-recourse debt.
“The entire amount of non-recourse debt is deducted against the value of the asset encumbered by that debt,” says Ward. “That is, only the net equity is subject to U.S. estate taxation in the case of an asset subject to non-resource debt.”
Tomorrow: Beating the taxman through bequests, treaties and credits
Do you have questions? Would further assistance be helpful? Consultations regarding U.S. tax planning for real estate investments typically are C$1,200. However, through special arrangement with Canadian Real Estate Wealth you can benefit from a one-hour consultation with one of Ward Chisholm’s experienced tax lawyers for only C$600. Please call 301-986-2200 and let the receptionist know that you saw this special offer on the CREW website and would like to arrange a consultation.
The property bonanza over the past few years in the U.S. stretched from the decimated Detroit market to the warm and inviting Florida panhandle – but as Canadians, those deals have come with the spectre of high estate taxes on foreign owners.