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Now that Joe Biden has won the US presidency and the Democrats have gained control of the senate, Canadians investing in US real estate will need to know how Biden’s tax proposal will affect their US investments.
Let’s take a look at the following ways that US investments could be affected:
Biden has proposed to reduce the US estate tax exemption from US$11.6 million to US$3.5 million (23.2 million and 7 million for married couples) and to increase the top estate tax rate from 40% to 45%. Currently, only Canadians with worldwide estates exceeding $11.6 million are subject to US estate tax on their US assets, including US real estate and shares in US corporations. The reduction in exemption means many more Canadians will be exposed to US estate tax.
For example, a non-married Canadian individual with a $1 million US vacation home and a worldwide estate of $5 million would have no estate tax on his or her death under the current law, but would have a potential $135,000 estate tax exposure under the new Biden tax proposal. Canadian residents with significant US assets should review whether or not they are now exposed to US estate tax and if so, they would be advised to revisit their estate planning. Canadian entities, such as trusts, partnerships and corporations may all be effective tools in reducing exposure to US estate tax.
Under the current tax law, tax basis of US properties are “stepped up” to their fair market value on the owner’s death. Biden, on the other hand, has proposed to eliminate this step-up. Therefore, there may be double taxation on a US real property held by a Canadian who has passed away, as the Canadian decedent would be subject to Canadian income tax on the deemed sale of his or her US property, while his or her beneficiary would then be subject to US income tax on the same gain when the property is sold. This double taxation can be avoided by making certain elections under the Canada-US tax treaty.
Biden has proposed to increase the US federal corporate income tax rates from 21% to 28%. Under the current rules, Canadian corporations investing in the US either directly or through a US subsidiary corporation are usually indifferent between having their profits taxed in the US or Canada. Going forward, Canadian corporations with US investments may want to restructure their financing and operations so that more of their profits can be shifted to Canada.
The current top US federal personal income tax rates are 37% on ordinary income and 20% on capital gains. Biden has proposed to increase the top rates to 39.6% on ordinary income over $400,000 and capital gains on income over $1,000,000.
Investing in US real estate personally or through partnerships have been the most tax efficient structures for Canadians as they are able to take advantage of the preferential long-term capital gain tax rates in the US. Moving forward, with the new laws in place, Canadians with significant US real estate investments may want to consider restructuring or see a substantial tax increase when the gain is realized on their US real estate holdings.