Tax Tips for Real Estate Investors

By: Allan Madan, CPA, CAMadan Chartered Accountant

Topic of discussion:

•Pros / Cons•Types of ownership•U.S. tax forms

Personal investment

Personal investment

Pros Cons

• Simplest structure – no significant set up cost

• Lower annual compliance cost (tax, state, etc)

• Easier to obtain mortgage

• Access to the U.S.’ long term capital gain tax rate (if held > 1 year)

• no liability protection (insurance is a must)

• Estate tax may apply for individuals with over $5M in worldwide net assets

• Probate fees may apply depending on each state

Personal investment

Estate tax in more detailo Unlike Canada which imposes tax on the accrued gain of a

deceased taxpayer at the time of death, the U.S. imposes tax on the net asset of the taxpayer at the time of death

o For Canadians that are not US residents, estate tax applies on the value of their U.S. assets if the FMV of their worldwide assets exceed $5.34Million (2014)

Personal investmentEstate tax in more detailo Under the Canada – U.S. tax treaty,

U.S. allows two major credits to reduce or eliminate estate tax for Canadian residents:o Unified credito Marital credit

Personal investment

Estate tax – Unified credit

The U.S. allows Canadian taxpayer to reduce their U.S. estate tax liability by the following amount:

Personal investment

Estate tax – Unified credit – Example

Facto U.S. stock holding:

$1Mo U.S. Real estate:

$2Mo Total worldwide

asset: $10M

US estate tax $1,145,800

Less: Unified credit $624,540

US estate tax $521,260

Personal investment

Estate tax – Marital credit

The U.S. allows Canadian taxpayer to double the unified credit if the U.S. assets are passed on to their Canadian resident spouse

Personal investment

Estate tax – Unified & Marital credit – Example

Facto U.S. stock holding: $1Mo U.S. Real estate: $2Mo Total worldwide asset:

$10M* U.S. estate tax liability

cannot be reduced to below zero

US estate tax $1,145,800

Less: Unified credit

$624,540

Less: Marital credit

$521,260*

US estate tax $0

Personal investmentEstate tax – How to plan

for ito Life insuranceo Consider different

structure including Canadian corporation (be aware of double tax)

o Obtain non-recourse mortgage for U.S. property (reduces value of U.S. asset)

Personal investment

Tax reporting – each investor must obtain/submit:

o Individual Taxpayer Identification Number (ITIN)

o Form W8-ECI to property manager (reduces withholding tax to 0%; else 30% applies)

o Form 1040NR – U.S. Nonresident Alien Income Tax Return (Usually due June 15)

Topic of discussion:

•U.S. Limited Partnership•U.S. Limited Liability Limited Partnership•Potential structures for avoiding estate tax•U.S. tax forms

Investment via U.S. Structure

U.S. Limited Partnership

Pro Con

• Offers limited liability protection for investors (the general partner bears the risk)

• No double taxation issue

• Flexibility in terms of adding or removing investors

• Set up cost can be significant

• Must manage various annual tax and other compliance requirements

• Estate tax will apply on the U.S. Partnership interest (considered U.S. – situs asset)

Sample structure:

U.S.

Canada

U.S. C-Corp (General Partner)

U.S. Limited Partnership

Husband (Limited Partner)

Wife (Limited Partner)

U.S. Real estate

49.5%

49.5%

1%

U.S. Limited Partnership

U.S. Limited Liability Limited Partnershipo Only available in certain states (~27

states)o Florida, Arizona, Hawaii, Texas, Illinois,

Iowa, etc

o Works same as limited partnership except the general partner also has limited liability protection (ie. every partner has limited liability protection)

o No need for another C-Corp to act as general partner (reduces set up and annual compliance cost)

Structure idea:

U.S.

Canada

U.S. LLLP

Husband Wife

U.S. Real estate

49% Limited Partner

1% General Partner

1% General Partner

49% Limited Partner

U.S. Limited Liability Limited Partnership

Upon death, the Canadian’s U.S.

partnership interest will

constitute part of his/her U.S. asset for the

purpose of U.S. estate tax

A potential solution is to own the U.S. partnership

interest via a Canadian

partnership

A Canadian partnership

interest does not constitute

U.S. asset

Potential Structure for Avoiding Estate Tax

U.S.

Canada

Canadian Corp (General

Partner)

U.S. Limited Partnership

Husband (Limited Partner)

Wife (Limited Partner)

U.S. Real estate

1%

U.S. Limited Partnership (Limited Partner)

1%

49.5% 49.5%

99%

Potential structure for avoiding estate tax

o Caution:o The IRS have not

formally declared whether they will consider Canadian partnership interest which holds U.S. real estate partnership interest as part of U.S. assets for the purpose of U.S. estate tax

U.S. tax reportingo Personal Obligations:

o Obtain ITINo Submit Form W8-ECI to the

partnershipo File Form 1040NR – Nonresident Alien

Income Tax Return

o Partnership Obligations:o Remit withholding tax on a quarterly

basis (39.6% of income attributable to non-U.S. partners)

o File Form 8804/8805/1065 by March 15 (Partnership returns)

Partnership Obligations (cont’d):• File annual compliance

form with fee to the State (non-tax)

Corporation Obligations:• File Form 1120 or

1120-F by March 15 (Corporate tax return

• File annual compliance form with fee to the State (non-tax)

U.S. tax reporting

U.S. tax reporting - remindero Most state also require

separate tax filing which may or may not have the same filing due date as the federal returns mentioned in the presentation

o Same with withholding tax requirements

Double Tax Problemo S Corporationso LLCo Flow-through for USo Corporation for Canada

Three tier structure for investment properties

o The Three tier structure is designed for and used by real estate investors. It consists of three corporations:

1) A management corporation2) A Real Estate company3) Holding corporationo For more information, please

visit http://madanca.com/blog/benefits-three-tier-structure-real-estate-investors/

o Tax Account Numbero Mandatory to obtain a tax account number so the CRA can

track your tax filingso Withholding Tax

o Withholding tax applies at a rate of 25% on the rents that you collect in Canada

o NR6 Formo This form reduces the withholding tax

Tax Issue for Non-Resident Investors

o NR4 Slipo This slip reports the gross rents you collected and

the total withholding tax you remitted to the CRA.o You have to collect this form no later than March 31st

of the following year or you will face a penaltyo Annual Tax Returns

o Annual tax returns must be filedo Section 216 tax return is due by June 30th of the

following yearFor more information, please visit

http://madanca.com/blog/non-resident-tax-on-rental-properties-in-canada/

Continued...

Disclaimero The information provided in this presentation

is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this presentation.