Are you a Canadian investor considering purchasing property in the United States? Before you dive in, pause for a moment and consider this: Choosing the wrong ownership structure can cost you thousands of dollars in unnecessary taxes. Today, let’s explore step-by-step the best structures available to Canadians for owning U.S. real estate, helping you avoid costly tax pitfalls.
Common Mistakes Canadians Make When Buying U.S. Property
As a Canadian tax resident, you must report your worldwide income. This includes income earned from any country, whether it’s Barbados, Dubai, or the United States. Similarly, foreign governments require you to file taxes on rental income earned within their borders.
This means that when you own rental property in the U.S., you need to report your income twice: once to the IRS and again to the CRA in Canada. Naturally, this might raise concerns about double taxation.
Fortunately, Canada recognizes taxes paid to the U.S. as a tax credit, offsetting Canadian taxes on the same income. Essentially, you’ll only pay taxes equal to the higher rate of the two countries. However, two key principles must be observed to ensure this:
- You need the right ownership structure recognized by both countries.
- Income or deductions must be reported simultaneously on both sides of the border.
What Is an LLC, and Why Isn’t It Ideal for Canadians?
LLCs, or Limited Liability Companies, are highly popular in the U.S., providing legal protection similar to corporations. This means your personal assets remain separate and protected from business liabilities.
From an accounting perspective, an LLC is treated as a disregarded entity by the IRS—meaning profits flow directly to your personal tax return. However, the Canada Revenue Agency (CRA) views an LLC as a foreign corporation, creating mismatches in tax treatment and potentially causing double taxation.
For instance, if your Florida condo generates $20,000 in rental income, you’d pay personal U.S. tax, but the CRA would tax the LLC as a corporation, effectively causing you to be taxed twice on the same income when you withdraw profits.
So, what’s the better alternative?
Personal Ownership: Pros and Cons
Pros:
- Simple tax reporting.
- Rental income directly reported on your personal tax returns.
- Easy to claim foreign tax credits, avoiding double taxation.
- Low-cost setup and filing fees.
Cons:
- No protection for your personal assets.
- Difficulties in opening U.S. bank accounts without local tax IDs.
- Least tax-efficient for business owners transferring funds from Canadian corporations.
This structure is ideal for smaller, lower-risk properties.
Canadian Corporation Ownership: Pros and Cons
Pros:
- Strong asset protection.
- Clearly separated business and personal finances.
- Beneficial if using funds from your Canadian corporate small business.
- Avoids U.S. estate taxes.
- Recognized by both CRA and IRS, effectively preventing double taxation through foreign tax credits.
Cons:
- Complex and costly tax filings.
- Additional U.S. branch tax.
- Difficulty in securing U.S. financing for a foreign corporation.
- Operational challenges, like banking and contract handling, as a foreign entity.
This structure is suited for larger investments or multiple property portfolios.
Limited Partnership (LP): The Ideal Structure for Most Canadians
A U.S. Limited Partnership (LP) is often considered the gold standard for Canadian investors. Simply put, an LP involves:
- A General Partner managing the property with full liability.
- Limited Partners who invest passively, their liability limited to their invested amount, protecting personal assets.
Why is an LP Ideal?
- Both CRA and IRS recognize an LP as a flow-through entity, ensuring tax and income reporting match perfectly, avoiding double taxation.
- Legal protection provided through a U.S. LLC or corporation as the General Partner.
Pros of LP:
- Clear recognition by CRA and IRS.
- Full asset protection for limited partners.
- No double taxation.
- Avoids U.S. estate taxes.
Cons of LP:
- Slightly complex and costly initial setup.
- Requires professional legal and accounting assistance.
- Higher ongoing filing costs, including separate LP and personal tax filings.
Example Scenario:
Sarah from Vancouver purchases a Texas rental property via an LP. The LP structure:
- Passes rental income directly to her.
- Allows her to pay U.S. taxes personally.
- Enables Sarah to claim foreign tax credits on her Canadian tax returns.
- Provides comprehensive asset protection.
Quick Summary
- LLC: Easy but leads to double taxation.
- Personal Ownership: Simple but lacks protection.
- Canadian Corporation: Protective but complex.
- U.S. LP: Optimal balance of protection and tax efficiency.
Conclusion
Choosing the right structure is essential. The wrong decision can be costly, but the correct choice significantly simplifies your tax obligations and ensures peace of mind. For personalized guidance, consider reaching out for a professional consultation.
Remember to like, subscribe, and follow our channel for more insightful cross-border tax tips!
Until next time, happy Canadian Real Estate Investing.
Cherry Chan, CPA, CA
Your Real Estate Accountant
