U.S. Estate Taxes and the U.S. Vacation Home #212

By Gerry Neely
B.A., LL.B.

The death of a client who owned a U.S. vacation condominium revealed how punitive are U.S. federal estate taxes for Canadian citizens who are not domiciled in the United States. The condo was purchased for $150,000, several years ago, and valued at $180,000 at the date of death. Title was subject to a $90,000 recourse mortgage and the U.S. federal estate tax liability is approximately $33,000.

In a recent article in a publication of the Vancouver Bar Association¹, an example was given of a U.S. federal tax of $57,800 levied on a condo valued at $250,000 at the date of death of the Canadian citizen. A U.S. tax credit of $13,000 sheltered the first $60,000 of value, but estate tax rates ranging from 18% to a high of 55% account for such substantial tax liabilities.

One oddity of U.S. estate tax law concerns the distinction made between a recourse and a non-recourse mortgage. The mortgages with which we are familiar are recourse mortgages, which give the mortgagee the right to foreclose against the property and to sue the borrower personally. A non-recourse mortgage limits the mortgagee's rights only to the property.

If the $90,000 mortgage against the client's title had been a non-recourse mortgage, $90,000 would have been deducted from the fair market value of $180,000 leaving only $90,000 to be taxed. As a recourse mortgage however, the $90,000 was treated as a debt of the entire estate of the deceased, which of course included his Canadian assets. The result was that only about 10% of the mortgage or $9,000 was deducted leaving $171,000 to be taxed.

The authors of this article commented that the combination of U.S. estate taxes and Canadian capital gains tax, neither of which can be credited against each other, may lead to a tax liability approaching the fair market value of the property. What estate planning can someone do who would like to have some assets to leave to heirs? The time to do estate planning is before, rather than after the purchase, because unraveling ownership may create a tax liability.

For example, a husband a wife purchasing a condominium would likely be advised to put title in their names as joint tenants to minimize cost and delay upon the transfer of title of the first of them to die. However, this may result in more tax liability upon their successive deaths, than if the property had been registered in their names as tenants in common, and their wills gave the survivor of them a life interest in the deceased's half interest.

Estate planning alternatives include life insurance; joint ownership with spouse and children; gifts; ownership through a sole purpose Canadian corporation. In addition, one can try to obtain a non-recourse mortgage either from relatives or a U.S. financial institution.

The sale of the property during the owners lifetime would reduce tax, but might be unacceptable because that would defeat the purpose for which the vacation home was purchased, and deprive the owner of cash now to benefit heirs later.

The authors of this article suggest that corporate ownership remains the most effective planning technique in most situations, although not without risk. Shares of a Canadian corporation incorporated solely for the purpose of owning the U.S. property are exempt from tax. Rental of the property may result in shareholders benefits being assessed for Canadian income tax purposes and the loss of special status of the Canadian corporation.

These tax planning alternatives involve both U.S. and Canadian consequences which warrant obtaining advice before any purchase is made or if made, before ownership is changed. (For those interested in getting more detailed information, the article is well worth reading. It may be purchased for $4.28 by telephoning Jill Roberts at the office of the Advocate, Vancouver, 925-2122, or by fax at 925-2065.)

1.

THE ADVOCATE, Volume 51, Part 4, July, 1993, Page 573, (The Dream Vacation Property South of the Border; An Estate Planning Nightmare? By: Elaine E. Reynolds, LLM, U.S. tax, Campney and Murphy; and Benita Loughlin, U.S. senior tax manager, Peat Marwick Thorne).

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