Finally getting the opportunity to do some traveling is often at the top of people’s lists when asked about their retirement plans.
It is important, though, to think about what exactly your travel plans are and how those plans will affect your time and financial situation. For some people, travel means visiting exotic locations around the world, for others it is spending an extended time in a southern location such as Florida during the Canadian winters.
Here are some issues you should consider if you want to travel internationally or become a “snowbird”, heading for a sunny southern climate.
TAX IMPACT OF SPENDING TIME OUTSIDE CANADA
Not surprisingly, there are serious tax consequences relating to residency. For example, the U.S. authorities will apply what is known as the ‘Substantial Residence’ test. The test says that the number of days that you spend in the US in the current year, plus 1/3 of the days you spent in the U.S. last year, plus 1/6 of the days you spent in the U.S. two years ago cannot add up to more than 182 days. If you exceed that limit, you will be subject to US taxation on your worldwide income. Looked at another way, you can consistently spend up to 121 days (about four months) in the U.S. annually before accumulating the 182 days that will make you subject to U.S. tax.
121 days (Yr1) + 40 days (1/3 of Yr2) + 20 days (1/6 of Yr3) = 181 days, just under the limit.
If your primary residential ties are with Canada, paying U.S. tax may be avoided by filing Internal Revenue Service Form 8840, The Closer Connection Exception Statement for Aliens.
To maintain your Canadian residency status, the same 182-day rule applies for any other country. However, the tax situation is different in other countries and is affected by whether Canada has a tax treaty with the country or not. When considering taking up partial residency and/or buying property in a different country, you should be speaking to a qualified tax and/or legal advisor.
PURCHASING REAL ESTATE IN THE UNITED STATES
With a stronger Canadian dollar and falling house prices in the U.S., you may be wondering if you should buy property south of the border. Prices are down and foreclosures are up – making the opportunity look even stronger for Canadians with the financial resources to cross-border property shop.
Buying property in the U.S. isn’t like buying property in Canada, however. There are many rules you need to be aware of when investing in the U.S. For example:
- If you plan on renting the property part of the year, you must have an American Social Security Number and file a U.S. tax return.
- You will have to pay higher property taxes in Florida if you are not a permanent resident.
- You will have to pay a 45% estate tax on your U.S. property if your worldwide assets are more than $2 million when you die.
- You also have to pay a gift tax ranging between 18% and 48% when you pass the property onto your survivors.
- Each state has different rules about withholding tax if you sell the property as a foreign owner.
In addition, you are taking on a huge currency risk. When you exchange Canadian dollars for U.S. dollars, you will be subject to the ‘spot’ rate at the time or the rate determined by the foreign exchange markets on a given day. However, ‘forward’ transactions can be made where you can lock in a specific rate for a specified time period. This can be beneficial in situations where a property is bought or sold, but there will not be an actual exchange of cash until some time in the future, perhaps three months. A forward currency contract will ensure that the amount of cash to be paid or received can be guaranteed. Your Advisor can help you decide if this is a strategy suitable to your personal circumstances.
The bottom line is that, while it may be an attractive time to buy in the U.S., you need to get professional advice from experts who know both Canadian and American tax, estate and real estate laws. While it would be nice to enjoy an ocean-side condo each winter, you wouldn’t want any nasty surprises to take the joy out of your purchase.
RENTING OUT REAL ESTATE IN THE UNITED STATES
If you have purchased a U.S. property it is likely that you will only be there for a few months of the year and may want to rent it out in your absence. This can certainly be done, but there are tax consequences. On the U.S. side, the renter has the choice of either paying a 30% withholding tax or else filing tax form 104ONR with the I.R.S. As far as Canadian tax, the rental income earned in the U.S. must be included in your income, but there are usually offsetting tax credits available. Professional advice should definitely be consulted to determine your tax status.
SELLING A PROPERTY IN THE UNITED STATES
If you sell a U.S. property you will be subject to tax in the U.S. on the gain on the property. Several factors can come into play, but generally if the property has been held for less than 12 months, the tax rate will be at the U.S. graduated rates. If held for longer, the rate will be 15%. The gain on the sale of a U.S. property must also be reported for Canadian tax purposes and adjusted for foreign exchange. However, this potential double taxation can usually be offset by the foreign tax credit.
ESTATE PLANNING AND THE UNITED STATES
U.S. tax law will levy tax on death on the fair market value of certain assets held in the U.S. by Canadians. These taxable assets will include real estate, certain personal assets such as vehicles and shares of U.S. corporations, among others. Canadian tax law will also tax these assets on death, but there are tax credits available that will reduce the chance of double taxation. Professional tax advice should definitely be sought where there are U.S. assets involved. There are also strategies available while you are alive to plan for and reduce the effect of U.S. taxation.
