Whether it be to escape the cold winter months, for retirement purposes or as an investment, many Canadian citizens own property in the United-States. Consequently, many of these owners are advised by other Canadian owners and/or possibly American lawyers to transfer their property to their children without tax consequences. A frequently advised strategy is to put their children on the property titles by donating (gifting) an interest in the property to them. By doing so, the property can be transferred without having to pay fees associated with probate. In simple terms, probate can be explained as a legal procedure in which the court determines the validity of a person's will. Probate fees can cost between 2-7% of the total value of the estate. Despite the fact the objective will be met, the advice can nevertheless be misleading. It does not account for the potential ramifications that can be incurred. Such a transfer can prove to have serious tax consequences in the United States for Canadian citizens.
U.S Tax scheme for gifts
Gifting a property situated in the United States is taxable. Thus, a Canadian citizen who is thinking of transferring his/her vacation, retirement or income property must consider the tax implications of undertaking the transaction. This tax is commonly referred to as the US gift tax by American authorities. Under this tax, a person who disposes of a property for less than the property’s fair market value (“FMV”) must pay a tax according to the actual FMV of the property. To evaluate the US tax liability associated with a gift of property, an evaluation of the property's taxable value must be done. The taxable value of a property can be understood as the FMV of the property minus the applicable exemption amount the taxpayer is entitled to.
U.S gift tax exemptions
Canadians are entitled to two annual exemption amounts that may be deducted when calculating the taxable value of a property situated in the United States:
(1) a USD $152,000 exemption for gifts between spouses;
(2) a USD $15,000 exemption for gifts to persons other than spouses.
The first exemption amount is annually adjusted for inflation, but the second exemption is subject to not annual adjustments.
It is important to note that gifts over the abovementioned applicable exemption amounts are taxed at a 40% rate. Additionally, a Canadian citizen's failure to report gifts in the US and pay tax on it will result in the accrual of interest and penalties.
Consider the following example illustrating the application of the U.S. Gift tax and the applicable exemptions.
Brandon is a Canadian citizen and the owner of a vacation condo in Fort-Lauderdale, Florida. The condo’s fair market value is currently US$400,000. On his friends' advice back in Canada, he is considering putting his wife Judy and 2 kids on the property title to avoid paying probate fees in Florida, which can range between 3-5% of the estate's total value.
John decides to gift a 25% interest to his wife, and 50% interest is divided equally to his children. This amounts to US$100,00 to his wife and US$100,000 to each of his children.
Because Judy is his wife, the US$100,000 gift will not be taxable because it meets the criteria of the first exemption mentioned above, meaning John can claim the US$152,000 exemptions for a spousal gift. As for the interest given to his 2 children, Brandon will have to pay US Gift tax because the fair market value of the gifts exceeds the US$15,000 threshold in meeting the criteria. Thus, the gifts to his children will have a total tax liability of US$85,000, which results from the total gift amount of US$100,000 minus the US$15,000 exemption. The amount of tax paid by Brandon of the interest given to his two children will be US$34,000, which represents 40% of the amount over the applicable exemption (40% of 85,000 = 34,000).
The abovementioned information is meant to highlight the importance of understanding the U.S. rules on gifts. The United States has different rules on gifts than those of Canada. It is always prudent to consult a relevant tax authority when contemplating gifting a US property to a family member, friend. At Meditax, our experienced lawyers and tax specialists are well versed in the applicable tax rules in the US and Canada. They can help achieve your goals while minimizing tax liabilities.