Is your cross-border property in your estate plan?

Transcript

Intro Speaker:  

Hello, and welcome to Matters Beyond Wealth with your host, Leanne Kaufman, president and CEO of RBC Royal Trust. For most of us, talking about subjects like aging, late life, and estate planning isn’t easy. That’s why we’re going to help get the conversation started on this podcast while benefiting from the insights and expertise of some of the country’s top experts. We want to bring you information today that will help to protect you and your family in the future. Now, here’s your host, Leanne.

Leanne Kaufman:

What has no wings but flies south every winter? The answer, snowbirds, meaning Canadians, generally age 55 and up, who head south to escape the winter months by living outside Canada for at least 30 days a year. This growing trend to winter outside of Canada is becoming increasingly popular, with up to 375,000 Canadians doing so every year. Even Canadians who don’t consider themselves snowbirds may own property south of the border or have other U.S.-based assets that could impact their planning.

Hello, I’m Leanne Kaufman, and welcome to RBC Wealth Management Canada’s Matters Beyond Wealth. With me today is Jim Yager, Consultant Cross-Border Tax at RBC Family Office Services. Jim specializes in providing cross-border tax planning. Prior to joining RBC, he was the practice leader of KPMG’s International Executive Services and Global Wealth Services. As both a Canadian Chartered Professional Accountant and a U.S. certified public accountant, and having been an expatriate for almost three decades, he is well-positioned to speak to us on this topic today.

Jim, thanks for being here with me today to discuss the impact of U.S.-based assets on Canadians’ tax and estate planning, and why this matters beyond wealth.

Jim Yager:

Thank you, Leanne.

Leanne Kaufman:

So, let’s start with some really kind of basic information here. And I know there’s nothing basic or simple about this topic, but when would a Canadian citizen and resident potentially be subject to U.S. estate tax?

Jim Yager:

Well, first of all, if by any chance that Canadian citizen and resident is a U.S. citizen as well, then they would be subject to U.S. estate tax on their global estate, no matter where it is located. But let’s say that the person who’s a Canadian resident is not a U.S. citizen, then they would be subject to U.S. estate tax on U.S. situs assets. And U.S. situs assets include U.S. real property, shares of U.S. equity, shares of a U.S. corporation, tangible property located in the United States such as cars, boats, furniture, artwork, U.S. retirement plans such as 401k plans, individual retirement accounts, obligations of U.S. persons, and even stock options and deferred compensation if you’re employed by a U.S. company.

It does not include shares of non-U.S. companies. So, for example, let’s say we have a Canadian corporation that owns…all its assets are U.S. situs assets. That’s not considered to be U.S. situs property. So that insulates the person from U.S. estate tax, and therefore, if a Canadian invests in Canadian mutual funds or Canadian ETFs where all those assets are U.S. situs, they are protected from U.S. estate tax.

Also exempt would be U.S. Bank deposits, U.S. corporate debt that qualify for the U.S. portfolio debt obligation exception, U.S. federal debt obligation such as T-bills and T-bonds. In addition, each person gets an exemption amount. For example, a U.S. citizen, currently the exemption amount is 12.92 million dollars, and this is adjusted each year by inflation. Now, under U.S. law, that amount will be reduced by 50 percent after 2025.

The treaty does provide an additional exemption amount to a person who’s not a U.S. citizen. For example, you get a portion of this 12.92 million dollars based on the proportion of your global wealth that’s situated within the United States. So, for example, let’s say 30 percent of your global assets are U.S. situs assets, you’d get 30 percent of that exemption amount, or 3.9 million, approximately 2 million after 2025. And the exemption amount can be doubled if you transfer your U.S. situs assets to your spouse.

Leanne Kaufman:

So, it sounds like 2025 is an important year that people should be paying attention to if they’ve got U.S. situs assets. Is that fair?

Jim Yager:

Well, they have to take into account that the exemption amount is cut in half.

Leanne Kaufman:

And the other thing your answer has demonstrated to me is just how complicated it is based on the nature of the assets and the ownership chain of the assets. So shares of Apple stock in your personal portfolio may be a problem. Shares of Apple stock held in a private holding company or held inside a mutual fund or some other bundled asset, maybe not a problem. So all reasons to get advice, I think is what I’m learning here. So, let’s say those U.S. assets are held in a Canadian registered account, an RRSP or a RRIF. Are they subject to the U.S. estate tax at death?

Jim Yager:

Unfortunately, the answer is yes. Having it in a plan like that does not insulate you from the U.S. estate tax. However, Canada will allow you a credit against the Canadian federal taxes that you’ll pay at death on the RRSP or RRIF. So therefore, you do get some relief for the federal tax that would be imposed, and therefore it may not make sense to roll it over to your spouse, recognize the tax at your death, and therefore get the credit.

Leanne Kaufman:

Oh, that’s a good tip. That’s another reason to get some knowledgeable cross-border advice. You must, in your role, see all kinds of situations kind of gone awry and talk to people that maybe had some misconceptions about all of this, which would be easy to do given how complex it is. What are some of those common misconceptions or pitfalls that you have seen occur when people don’t get the right advice before acquiring U.S.-based assets?

Jim Yager:

Well, something to keep in mind, even if you do, you won’t have any U.S. estate tax liability because you’re under the exemption amount. In order to get the exemption, the enhanced exemption for a Canadian resident, you have to file a return if your U.S. situs assets exceed $60,000. So that’s something to keep in mind. Another thing that I hear frequently is “Why worry about it? I’ll be dead. No one will really find out.” Well, something to keep in mind is that the liability is on your executors, your trustees, and even your beneficiaries. So unless you really focus on these rules, those people are the ones that are going to have to deal with this issue when you’re gone.

Leanne Kaufman:

Well, and this isn’t the only issue or topic where we sometimes hear people make that claim, “What do I care? I’ll be dead.” Well, it’s an act of love for the people you’re leaving behind to set it up right. Right?

Jim Yager:

For sure.

Leanne Kaufman:

Okay, so what about other forms of ownership? We talked about the registered plans. Some of our listeners may be aware of or may have an alter ego trust or a joint partner trust if they’ve set up that kind of planning. How about in that situation, if the U.S. situs assets are held in one of those trust structures, or maybe even just a standard Canadian inter vivos trust, what happens then? Are those assets insulated from the U.S. estate tax in that situation?

Jim Yager:

Unfortunately, no. Assets that are in a trust where there’s a reversionary interest to the settler, the settler is deemed to have a retained life’s interest, and therefore the settler would be deemed to own all the assets in the trust. Now, other types of trusts, irrevocable trusts, where the assets are actually transferred to a trust and there’s no retained life interest, then that would be out of your estate. But in trusts such as alter ego trusts and joint partner trusts, you would most likely not be insulated from the U.S. estate tax on assets in that trust.

Leanne Kaufman:

So, you must get asked this all the time, but what is a strategy or tactic that a Canadian citizen and resident would use to acquire U.S. vacation property and still try to avoid exposure to U.S. estate tax, if any?

Jim Yager:

Well, there isn’t any perfect structure, and it gets a little bit complicated. And one of the factors is, what’s the value of the property that you’re holding that’s located in the United States? So, for example, you may find that because your global wealth is under the 12.92 million and you’re not going to be exposed to U.S. estate tax, why get into a complicated structure? So if there is really no exposure to U.S. estate tax, I really wouldn’t worry about it too much, and really maybe focus on avoiding probate at death on assets in the United States.

Now, let’s say you go through the analysis and say, “Yes, I do have some exposure to U.S. estate tax and I would like to lower my U.S. situs assets that are subject to the estate tax.” Then there’s some simple things that can be done. For example, you could get a non-recourse mortgage, which can reduce the taxable value. Now, a non-recourse mortgage is different than a typical mortgage where the lender can only go after the property itself, and that can reduce the value of the property dollar for dollar. A regular mortgage can only reduce a portion of it and is not as effective at reducing the taxable estate.

Now, let’s say you have higher exposure to the U.S. estate tax. Some of the more common structures are a trust. And in the trust you can, for example, acquire the property by, one spouse would transfer cash to the trust, to an irrevocable trust, for the benefit of the other spouse, and then both spouses could actually use the property. But it’s an irrevocable trust, so therefore the spouse who sets it up can never get that money back, and therefore, if the other spouse passes away, then it goes to the kids, and then you have to, basically, if you want to use the property, rent the property from the kids.

So there are challenges to it, and you can’t transfer property to the trust. It has to be cash. For example, if you transfer property to it, that’s a Canadian deemed disposition. And also for U.S. tax purposes, that’s a taxable gift. So it can’t be existing property, it has to be transferring cash to acquire property. Now, for very valuable properties, a more complex structure, and this is really effective for properties, I’d say, at least a million dollars or more, would be a Canadian limited partnership. And in this type of structure, a person could transfer actually existing property without recognizing tax or gift tax to the LP in exchange for an LP interest.

And then in order to protect it from U.S. estate tax, for U.S. tax purposes, you would make an election to consider that partnership a corporation just for U.S. tax purposes. And by being considered a Canadian corporation, that would insulate you from the U.S. estate tax.

Leanne Kaufman:

When you talked about using the trust structure and having to have the trust set up to acquire the property, is that a Canadian trust you’re talking about or a U.S. trust?

Jim Yager:

Yes, it would be a Canadian trust.

Leanne Kaufman:

Canadian trust, yeah. Again, you kind of demonstrate the importance of keeping your eye on that exemption limit, because I know it’s a moving target. So the assumptions that we make today may not be applicable a few years from now. So it all points back to needing advice.

So I think, Jim, you’re such an expert in this, we could talk about it for hours, but if you hope that our listeners just remember one thing from the brief conversation we’ve had today, what would that be?

Jim Yager:

I think it’s important that Canadians look over their estate and see if there are any U.S. situs assets in their estate, whether it’s in their RRSP or in their investment portfolio or having property, and then quantifying what your exposure is and taking action if necessary to reduce the estate tax exposure, or at least have an understanding of it, and communicate it to your executors and to your heirs, so there’s no misunderstanding when you pass away.

Leanne Kaufman:

And if I might add, I would suggest that also making sure you do this kind of analysis before you acquire property in some instances, right?

Jim Yager:

For sure. Before you acquire any U.S. real estate, it makes sense to take that into account.

Leanne Kaufman:

Yeah. Well, that’s been really helpful and enlightening, and I’m sure we might leave people with more questions that they have, so we encourage them to reach out to their people in their network that can advise them in this regard, or to us at RBC. But thank you so much, Jim, for joining me today to talk about these important considerations and complications when it comes to cross-border estate planning and why this matters beyond wealth.

Jim Yager:

My pleasure. Thank you.

Leanne Kaufman:

You can find out more about Jim Yager at RBC Wealth Management’s website or on LinkedIn. If you enjoyed this episode and you’d like to help support the podcast, please feel free to share it with others, post about it on social media, or leave a rating and a review. Until next time, I’m Leanne Kaufman. Thank you for joining us.

Outro speaker:

Whether you are planning for your own estate, the needs of your family or business, or you are an executor for a loved one’s estate, we can help guide you, simplify the complex, and support your life’s vision. Partner with RBC Royal Trust and ensure your legacy will thrive for generations to come. Leave a legacy, not a burden™. Visit rbc.com/royaltrust.

Thank you for joining us on this episode of Matters Beyond Wealth. If you would like more information about RBC Royal Trust, please visit our website at rbc.com/royaltrust.