Holding Canadian Vacation Properties In A US Entity Avoids Exposure To Canadian Taxes On Death

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Many Americans hold interests in vacation or recreational properties in Canada. Often such properties are intended to be passed on from generation to generation.

Canada taxes U.S. residents on capital gains from the sale or other disposition of Canadian real estate, even if such real estate is held for recreational or vacation purposes.

Canada’s ability to tax U.S. residents on gains from the disposition of Canadian real estate is recognized in Article XIII(3) of the Canada-U.S. Tax Convention (“the Treaty”)

In addition, when a U.S. resident dies owning Canadian real estate, that individual will generally be deemed to have disposed of the property immediately before his or her death at fair market value. Thus, Canada taxes accrued capital gains on death (an exception can apply if such property is acquired by a spouse, or “spousal trust”).

If such real estate is held in a US corporation, whether a C Corporation, S Corporation, or LLC (which Canada treats as a corporation) Canadian tax should not apply on the death of the shareholder or member. This is because of the fact that Articles XIII(3) and XIII(4) of the Treaty effectively preclude Canada from taxing gains from the disposition of shares in real estate holding companies that are not resident in Canada.

In many cases, this may be a preferable alternative to the use of a “grantor trust”, since Canadian tax law provides for a deemed disposition of trust property, at fair market value, every 21 years.

What type of entity is best to use? If one assumes that the property will never be sold, it probably does not matter much. However, that would be a dangerous assumption, and Canada will tax the gain when the property is sold.

Likely, one can rule-out using a C Corporation because of the fact that any resulting capital gain will be taxed as ordinary income for US tax purposes, and there will be an extra level of tax when profits are distributed.

The use of either a LLC or S Corporation would avoid those two problems. However, the S Corporation would be preferable because, unlike the LLC, Canada views the S Corporation as being a resident of the U.S. for the purposes of the Treaty. This will be relevant in terms of the application of Canada’s “branch tax” under Part XIV of the Income Tax Act, and the ability to access the reduced (5%) rate provided under the Treaty.

In accordance with Circular 230 Disclosure

Mr. Atlas is a Toronto-based Chartered Accountant who practices as an independent consultant on a wide-range of international and domestic tax issues. Most of his practice consists of advising accounting and law firms on high-level tax issues. Prior to forming an independent tax practice in 1991, was Partner in charge of tax practice of major independent accounting firm in Toronto. Advises clients worldwide. Author of leading book, Canadian Taxation of Non-Residents, considered one of the few Canadian tax professionals, outside of the big accounting and law firms, who is an expert on high-level international tax matters.

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