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Florida properties: Beware the Tax Treatment

Palm Trees

In Spring 1967, three students of the educational institution now known as Ryerson University, trooped into a meeting at the United States Consulate General on University Avenue in Toronto. They had finished their courses, had started preparing for graduation, and saw their career aspirations as better served by moving south.

They had clean records and faced no obstacles to making the move. As the meeting ended and they headed for the door, the consulate official changed their plans with one statement. “Of course, you realize that after six months in the U. S. you would be eligible for the draft,” he said.

Joining the American troops fighting in Vietnam at the time did not seem appetizing and the trio immediately re-thought their plans.

Decades later, those three would-be expatriates have arrived at the age where many contemplate buying property and living all or part of their retirement years in Florida.

Instead of the siren call of better careers, these boomers feel attracted by the soft American housing market and currency parity.

This time around they may not have to abandon their plans, but have to take American tax regulations into account. RBC Wealth Management warned recently that Canadians heading south need to consider a range of tax and estate planning issues, and that failure to do so could have serious implications.

Owning a vacation or retirement property in Florida, or elsewhere in the U. S. and collecting rental income, involves a range of tax planning decisions.

In one option, the Canadian property owner can elect to pay a flat 30% tax on rental income but this option does not allow deduction of any expenses, making it the simplest but possibly the most expensive option.

In the other option, the Canadian can file a non-resident income return and claim all legitimate expenses including mandatory depreciation. In that scenario the net rental income for tax purposes will likely fall below the gross income subject to the 30% tax, according to an RBC analysis. In the latter case, returns and a cheque for the amount owing must be filed by June 15, an unfortunate date since it is also the Canadian tax filing deadline for self-employed individuals. The individual must also report the net income or loss on his or her Canadian tax return.

This situation also multiplies other forms of paperwork. Where the property owner gives a Power of Attorney to an individual to act on his or her behalf, it is advisable to execute a POA for each State in which the Canadian owns property.

Selling the rental property means reporting any capital gain or loss and paying tax on any profit. The basic calculation involves subtracting the adjusted cost base (ACB) from the sale price. Calculating the ACB means adding the initial purchase price, plus cost of improvements, and subtracting the mandatory depreciation. Where the property owner has not claimed the mandatory depreciation, the IRS will helpfully reduce the ACB as if it had been claimed, thereby raising the potential capital gains liability. Canadian tax regulations require reporting of the gain or loss but foreign tax credits might eliminate any tax liability on this side of the border.

The sale may also attract a 10% withholding tax from the proceeds unless the sale price is $300,000 or less and the purchaser plans to use the property as a principal residence. Where the property sells for below that threshold, the individual can apply for a withholding tax of less than 10% and must file an application with reasons before the closing date and specify the tax to be withheld.

Now, at year-end, another American tax regulation requires special attention to careful estate and tax-planning by Canadians, since a change in the wind could increase a Canadian’s tax liability.

“At the end of 2012, there will be a big change,” explains Alain Forget, Vice-President and Head of Sales and Business Development at RBC Bank, a wholly owned American subsidiary of the Royal Bank of Canada.

Until December 31st, if a Canadian owner of an American property deceases, regulations provide for an estate tax on the property of up to 35% with an exemption of up to $5.2 million on worldwide assets. In the absence of new legislation in the meantime, the top rate increase to 55% and the exemption falls to US$ 1 million.

“As well as real property, the calculation includes shares in American corporations,” Forget told Silver and Gold Magazine when reached in Florida recently. “Sometimes Canadians own those stocks in the portfolio… and they don’t think that those stocks are subject to U. S. estate tax as well as their U. S. real estate property.” Banks provide a range of strategies for dealing with these regulations.

Those guys from Ryerson still have to be careful.

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Al Emid is an author and financial journalist covering investing, banking and insurance, and has received a journalism fellowship in topics related to retirement issues.

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