From Our Partner: LegalShelf Company
Q. Should I hold US property in my own name?
A. You can, but it’s not ideal, at least from an asset protection point of view.
Q. What is the best entity choice for a Canadian who wants to hold US property?
A. That’s a really complex question. The answer will depend on what you want to do, who you’re doing it with, how much you want to spend, your long-term goals, and more. One solution would be a US Limited Partnership, with another company, either a Canadian corporation or a US corporation, acting as the General Partner, and you being the owner, or Limited Partner. You could also consider using a Canadian partnership that registers into the US.
Q. I have heard that most people buy real estate in an LLC – is that something I should do?
A. That depends. If you are buying real estate with the intent of holding it for a long time, and you want to immediately access the rental income and get the best capital gain rate on a future sale, absolutely not. The LLC will cost you money in that situation. But if you are buying properties with the idea of turning them over quickly, then an LLC can be an excellent vehicle, if used properly.
Q. What’s the difference from a tax perspective between holding property for rental income and buying properties to turn over quickly?
A. On the US side, rental income activity is considered to be a passive, investment activity. You have a lot of deductions to take against that income, which can often significantly reduce your tax rate. The income you generate through quickly buying and selling homes is taxed like a business. Again you have a lot of deductions you can take. But the real difference comes in a future sale. Long-term rental properties that are sold recognize their gain as a capital gain, which right now can be taxed at 20% in the US. But short-term properties that are bought and sold quickly don’t receive capital gains rates. Those will be taxed at regular corporate income tax rates, which can be anywhere from 25 to 35% or more.
Q. How do taxes impact me as a Canadian investing in the United States?
A. Taxes will impact you 3 main ways: income tax on money you earn, gains tax on the profit you make from a sale, and estate tax on the value of your US assets when you die. Each one has different rules and plans. It’s really hard to find a single solution that gives you the best of all worlds. If you plan only around estate taxes, you can pay more in income tax and capital gains tax. If you plan around income/gains tax, you can wind up with estate tax issues you weren’t expecting.
Q. How much will I pay in Taxes in the US?
A. That depends. You can pay as much as 30%, or considerably less – maybe even less than 10%. How much you pay depends on how you come into the US tax system, the entity type you use, and other factors.
Q. What is flow-through taxation? I hear that referred to a lot in US taxes.
A. Flow through taxation is an alternative tax mechanism used in the US. With regular corporate taxation, the corporation has its own tax rate. Income generated in the corporation is kept there. On its tax return, the corporation prepares its own tax return. It reports its income, deducts all available expenses, and winds up with its taxable income figure. Then taxes are paid on that figure, calculated on the corporation tax scale. With flow-through taxation once the entity has calculated its taxable income, the income is transferred to the owners. Each owner shows their share of the income on their individual tax return, and pays income tax at whatever their personal rate is. The entity still files a tax return, but it’s informational.
Q. Why do people say flow-through taxation is better?
A. It depends on the circumstances, but often flow-through taxation results in a lower overall tax bill. That’s because of something called double-taxation. Your corporation must pay tax on its income, and then if you take out the profit as a dividend, you have to pay tax again, this time on your personal return. When you add those two taxes together, they can often be higher than if you had dealt with the same amount of income in a flow-through company.
Q. Can you give a specific example of the tax calculation between a corporation and flow-through?
A. Sure. The answer is more complex usually, but this is a simple example. Let’s say your US corporation has $50,000 in taxable income. The tax on that is 15%, or $7,500. That leaves $42,500 in after-tax profit. You want to take out a dividend of $30,000. You have to declare that income on your personal return now, and pay dividend tax, which is 20%. So you pay another $6,000. You’ve paid a total of $13,500 in taxes. In the flow-through example, you would show $50,000 on your personal return, where it was taxed at your personal rate, which was about 25%. The tax bill in that case would have only been $12,500.
Q. How is that money taxed in Canada? Do I have to pay taxes twice?
A. Not in most cases. The US-Canada tax treaty allows you to offset what you pay in the United States against your Canadian tax bill, so you don’t wind up paying two times on the same dollar.
Q. I was told that investing with a corporation was best because I wouldn’t file personal income tax or have to pay US estate tax. Is that true?
A. Yes and no. If you set up a US corporation to hold your US real estate you won’t have to file a personal tax return – at least until you want to pull money out through a dividend. But when you pay that dividend you will face the same choice: lose 30% in tax or file a personal tax return in the US to get some of that 30% back.
With estate tax, it also depends. If you own a US corporation, partnership or property directly, you will fall under US estate tax rules. If you use a Canadian company or an offshore company you may not. BUT the US-Canada tax treaty also gives Canadians a very generous exemption from paying US estate taxes. Unless your total estate is over USD $5m, you likely won’t have to pay any US estate taxes.
Q. How hard is it to pay taxes in the US?
A. It’s actually quite easy. You’ll need to first register with the US tax authorities, aka the Internal Revenue Service, or IRS, to get a personal tax identification number. That will be the number you use on your personal tax return.
Q. When are taxes due in the US?
A. The due dates will differ, depending on your circumstances. A Corporation may have to pay estimated taxes quarterly. As an individual, you will likely need to pay personal income taxes by June 15th each year.
Q. When are tax returns due in the US?
A. Those dates will differ, depending on your circumstances. Partnerships file on or before April 15th each year. However, they can file an extension of time to file return that moves it out to September 15th, each year. Non-resident taxpayers file on or before June 15th each year, but again, you can extend that date out by 6 months, to December 15th. Corporations file 2.5 months after their fiscal year-end date. So if your corporation ends its year on December 31st, it would file on March 15th, unless it files for a 6-month extension of time. If its tax year ended on March 31st, the return would be due June 15th, and so on. If you have to also file a state tax return, that will follow the federal rules.
Q. What is an ITIN?
A. An ITIN is short for Individual Taxpayer Identification Number. It is an alternative to an American Social Security Number, or a Canadian Social Insurance Number. It is the number you get to identify you to the US tax system. You will need it to file a tax return in the US.
Q. How do I get an ITIN if I hold property personally?
A. There are a couple of ways to get one. If you hold property in your name, you can apply for an ITIN at the time you file your first tax return. The IRS will first process your ITIN application, and then, once you have an ITIN, they will process your tax return. But that means you have to wait until you file your first tax return. During the time that you are waiting, you can’t avoid the 30% withholding.
Q. How do I get an ITIN if I set up a US business structure?
A. If you set up a US business structure you are eligible to immediately apply for an ITIN. That’s one of the benefits to using a structure.
Q. How long does it take to get an ITIN?
A. The IRS has just changed their whole process and what used to take 3-4 months is now taking 2-4 weeks, from the time you submit your application.
Q. Do I need a US Bank Account?
A. It’s a really good idea to have one. Property Managers in the US are not always willing to write checks or send money out of the country to foreign bank accounts. Prepaid VISA cards are an option but if the cards are lost in transit there can be an issue over payment.
Q. What is Effectively Connected Income?
A. Effectively Connected Income, or ECI, is an election you make on how you want the IRS to characterize your income. If done properly it can significantly lower the amount of tax you pay in the US.
Q. What is FIRPTA?
A. FIRPTA is short for U.S. Foreign Investment in Real Estate Property Act (“FIRPTA”). Under FIRPTA, when someone buys your real estate property they are legally required to hold back 10% of the fair market value of that property to partially your gain tax on the sale. States may also have a form of FIRPTA that is on top of federal amounts. You may be able to offset the gain tax paid against the tax that will be payable in your home country. You may also be able to avoid FIRPTA by filing the correct documents with the IRS ahead of time – i.e. before you sell the property.