Tax Tips for Real Estate Investors By: Allan Madan, CPA, CA Madan Chartered Accountant Personal investment Topic of discussion: •Pros / Cons •Types of ownership •U.S. tax forms Personal investment Pros Cons • Simplest structure – no significant set up cost • no liability protection (insurance is a must) • Lower annual compliance cost (tax, state, etc) • Estate tax may apply for individuals with over $5M in worldwide net assets • Easier to obtain mortgage • Access to the U.S.’ long term capital gain tax rate (if held > 1 year) • Probate fees may apply depending on each state Personal investment Estate tax in more detail o 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 investment Estate tax in more detail o Under the Canada – U.S. tax treaty, U.S. allows two major credits to reduce or eliminate estate tax for Canadian residents: o Unified credit o 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 US estate tax $1,145,800 Less: Unified credit $624,540 US estate tax $521,260 Estate tax – Unified credit – Example Fact o U.S. stock holding: $1M o U.S. Real estate: $2M o Total worldwide asset: $10M 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 US estate tax $1,145,800 Less: Unified credit $624,540 Less: Marital credit $521,260* US estate tax $0 Estate tax – Unified & Marital credit – Example Fact o U.S. stock holding: $1M o U.S. Real estate: $2M o Total worldwide asset: $10M * U.S. estate tax liability cannot be reduced to below zero Personal investment Estate tax – How to plan for it o Life insurance o 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) Investment via U.S. Structure Topic of discussion: •U.S. Limited Partnership •U.S. Limited Liability Limited Partnership •Potential structures for avoiding estate tax •U.S. tax forms U.S. Limited Partnership Pro • Offers limited liability protection for investors (the general partner bears the risk) • No double taxation issue • Flexibility in terms of adding or removing investors Con • 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) U.S. Limited Partnership Sample structure: Husband (Limited Partner) 49.5% Canada U.S. Wife (Limited Partner) 49.5% U.S. C-Corp (General Partner) 1% U.S. Limited Partnership U.S. Real estate U.S. Limited Liability Limited Partnership o 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: Husband Canada U.S. Wife 1% General Partner 1% General Partner U.S. Limited Liability Limited Partnership U.S. LLLP 49% Limited Partner 49% Limited Partner U.S. Real estate Potential Structure for Avoiding Estate Tax 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 Husband (Limited Partner) Canadian Corp (General Wife (Limited Partner) Partner) 49.5% 49.5% 1% U.S. Limited Partnership (Limited Partner) Canada U.S. 1% 99% U.S. Limited Partnership U.S. Real estate 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 reporting o Personal Obligations: o Obtain ITIN o Submit Form W8-ECI to the partnership o 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) U.S. tax reporting 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 - reminder o 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 Problem o o o o S Corporations LLC Flow-through for US 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 corporation 2) A Real Estate company 3) Holding corporation o For more information, please visit http://madanca.com/blog/ben efits-three-tier-structure-realestate-investors/ Tax Issue for Non-Resident Investors o o o Tax Account Number o Mandatory to obtain a tax account number so the CRA can track your tax filings Withholding Tax o Withholding tax applies at a rate of 25% on the rents that you collect in Canada NR6 Form o This form reduces the withholding tax Continued...o o NR4 Slip o 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 penalty Annual Tax Returns o Annual tax returns must be filed o Section 216 tax return is due by June 30th of the following year For more information, please visit http://madanca.com/blog/non-resident-tax-onrental-properties-in-canada/ Disclaimer o 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.