There’s another Gold Rush happening in the United States real estate market, and Canadian investors are getting in on the action.
Joe Biden’s $1.9 trillion coronavirus relief package in March (which followed relief packages going back to the start of the pandemic) gave Americans a bit of relief, and many of them put the extra money directly into savings.
“There's an opportunity like never before in real estate, and it's all artificially created because of the stimulus,” says Scott Smith, head attorney at Royal Legal Solutions. “Savings rates are higher than they've ever been, so once the coronavirus scare is over and people are back to work and businesses are working again, people are going to be less afraid. They're going to spend, which means that we should expect a rapid influx of money over the course of about a year.”
So how do Canadian investors take advantage of this real estate Gold Rush? How do you start acquiring the right assets AND make sure that you’re protected so you don’t lose them in a lawsuit?
Scott recently discussed these issues with Canadian real estate investing coach David Dubeau and Lauren A. Cohen, a cross-border strategist experienced in both law and real estate who founded e-Council Global. Before you go, check out our article based on her Eight Steps to Successful Real Estate Investment Across Borders. You may also be interested in How Limited Partnerships Protect Canadians Investing in the United States.
There's a lot of opportunity awaiting Canadian investors in the U.S. real estate market. But before you can take advantage, you need to understand that it’s a different game in the U.S. You'll need to establish the proper legal framework to do business safely and profitably.
“I've heard of different nightmare scenarios where Canadian investors bought properties in the States and they weren't set up properly,” Lauren says. “And they either got double taxed or they got sued. They lost a ton of money.”
“As you might know, the United States is a very litigious country,” Scott adds. “We have unlimited liability here, which means that a single lawsuit can go after as much money as they want.”
Insurance is a component of asset protection, but proper corporate entity structuring is an often-overlooked aspect as well.
“Entity structuring is important because you can’t simply hope that the insurance company pays out. We know that insurance companies are profit-seeking corporations and that we can't rely on them to do the right thing, especially when claims get very expensive. That's why we use asset protection tools—to cap our losses,” Scott says. “Even in the worst case scenario we know we're going to be okay.”
“The goal of my firm is always to put our clients in a position that makes it look like they own nothing on paper," Scott explains. "People that don't look like they own anything don't get sued."
That's why the best asset protection strategies make Canadian real estate investors unattractive targets for litigious lawyers.
“And if you are sued, you lose little to nothing because of the protection and the structures are there to minimize damage.”
So … What are we looking for when we're building an asset protection structure?
You aren’t going to rely on an LLC, because LLCs in Canada are taxed at a corporate tax rate. Instead, you’ll use an entity called a Limited Partnership . The Limited Partnership offers unique asset protection benefits to Canadian real estate investors with assets in the United States. It protects your American-based assets while minimizing your tax responsibilities.
You can own this Limited Partnership (and all the assets underneath it) anonymously. Remember: People who look like they don't own anything don't get sued, so that’s your first line of defense.
The next part of a secure asset protection structure is the “secret sauce” for Canadian investors, because it will help you acquire assets with the best financing you can get.
A Land Trust will let you own the property anonymously. It also allows us to avoid something called the due on sale clause.
“This means you can actually buy the asset with the absolute best financing and then you can transfer it into the Land Trust and you don't have to worry about the bank having a problem with you transferring the asset because a Land Trust will avoid the due on sale clause of your mortgage.”
This is a huge cost saving measure for Canadian investors.
Holding the property underneath the Land Trust gives you access to better financing rates. Because the property is actually owned by (for example) “123 Main Street Trust” (according to the deed records), no one can get more information about that trust because everything about that trust relates back to a law firm an attorney—and all that information is protected by attorney-client privilege.
What if they sue the property anyway? What if grandma got hurt on the stairs and they're blaming you? They sue the Land Trust. And the liability there is blocked by the Limited Partnership.
"This means they're not able to to go after you personally," Scott explains. "Any of your personal assets or other assets are protected. The only thing that they'd be able to go after is just the one asset held in the Land Trust because the limited partnership structure is what caps it and stops it from being able to go after anything else.
In a Limited Partnership structure you (the Canadian investor) are the limited partner. The partnership also has a general partner—this will be an LLC or a C Corporation.
“Inside of a limited partnership, only the general partner is liable for actions taken—not the limited partners. That means that all of the income and all of the benefits flow to you as a limited partner. You don't have to pay any of the extra tax, but you get all of the protection of the limited partnership. If there's any liability, it’s going to be held by the LLC or C Corp—which don’t own anything.
There are worst-case scenarios they can attack an entity, but the only thing they're going to be able to attack here is an entity that doesn't own any assets.
The LLC is a great investment vehicle in the United States because it qualifies for pass-through treatment in the American tax system. However, Canadian laws treat the LLC differently. Corporate taxes apply to LLCs in Canada. As a result, the taxes are often too high for most investors to justify …. Unless they have a Limited Partnership.
Income taxes within Canada can be high, but the Limited Partnership agreement allows investors to gain liability protections while managing these profits in a tax-friendly manner. Of course, to reap these benefits, the LP must be properly constructed.
The Limited Partnership is a flow-through entity, so all income is taxed at the individual level. Income is also subject to U.S. federal income tax at the top marginal tax rate (currently 37%).
You will also be subject to Canadian taxation. However, thanks to the income tax treaty between the two countries, the U.S. tax paid counts as a foreign tax credit in Canada. This means the combined U.S. and Canadian tax on income on your real estate business would be 53.53% for (for example) an Ontario resident, since that is the top marginal tax rate in that province.
At Royal Legal, we hate corporate tax rates. The cool thing about Limited Partnerships is that they provide the exact same protections that an LLC does, but you don't get hit with corporate tax rates. All of the money flows from the investment property, to the Limited Partnership, then to you. The money never touches the LLC or C Corp.
“So for tax purposes all of the money is treated as a disregarded entity or a pass-through entity; the money never touches an LLC but all of the liability will rest inside of the LLC or C Corp.
For more information, see our article How Are Canadians Taxed If They Invest Or Do Business in The United States.
You may acquire assets directly in the name of the Limited Partnership. However, some of Scott’s Canadian clients can get better financing rates if they acquire the asset inside of their personal name first.
“That's not a problem either,” Scott says. “You can just acquire that asset inside of your personal name, then create the Land Trust. Next, you’ll create a warranty deed to transfer the asset it into the Land Trust so then it's now held by the Limited Partnership.”
No matter what type of financing or what type of asset you’re working with, you're going to be able to find the way to hold that asset anonymously, in a way that's protected. You're also going to be able to always be able to take advantage of the best possible financing and have the best possible tax advantages.
You will designate all the investors taking part inside of your Limited Partnership documents. Is there one person or multiple people? Each of them should probably have independent advice as well just to make sure that their structures are set up properly.
If it's just a few people (your friends and family, for example), you're typically never going to have a problem.
If there's any type of fund arrangement, you may need to consult a U.S.-based securities/SEC attorney.
“The best way to make sure that you're not double taxed is to be very clear about where your residence is,” Lauren says.
Treaty Investor (E-2) visas are for citizens of countries with which the United States maintains treaties of commerce. The visa gives you, the private investor, the flexibility to invest across the border without moving.
“If you do have an E-2 visa you need to keep track of exactly where you are at any given time. I will not work with anybody that does not get cross-border tax guidance—no matter what country they're from. Whether you're immigrating or not you need that cross-border tax guidance.”
There's a lot of people licensed in Canada to help people with U.S. immigration or U.S. investing. But you still need a U.S. contact.
“I have colleagues on my team that are licensed in the U.S. and Canada, so they're tax experts on both sides of the border,” Lauren says. “To me that's the best way to go because it's seamless.”
At the end of the day, the Limited Partnership structure is the ideal structure to avoid and minimize your taxes.
“The CRA will tax the entity," Laura says. "That's why the structure is so important because if you set it up this way your tax liability is going to be minimized. But this is definitely a question for your tax advisor."
“Typically what we want to do is hold no more than $500,000 in equity in any one Limited Partnership structure,” Scott advises. “If we're underneath that threshold (assuming all these assets are inside of the same state), then what we'll do is we'll just create additional Land Trusts and hold additional properties underneath the additional Land Trusts.”
If an investor faces a lawsuit against one asset inside of one Limited Partnership, the litigant can target all of the assets held there. This is why we cap the amount of equity at $500,000.
“If you're risk averse, you can lower this $500,000 threshold and hold fewer properties in the LP. Or if you're buying multiple assets in different states, you do one Limited Partnership per state”
What does the Limited Partnership structure cost? Along with the LLCs, they can cost between $4,500 to $12,000. On the Canadian side of things you have to consider the taxes as a primary concern because the taxes will always outweigh the costs of additional structuring.
Limited Partnerships are a type of entity structure that allow you to own active investments (flipping for example). It can also allow passive investments (for example, single family homes that you’re leasing out and typically holding those for more than a year).
A limited partner in a Limited Partnership is a passive member; the general partner is the active component of the partnership. The “active” component in U.S. litigation is the one that bears all the liability.
Canadian investors need an active business to qualify for a visa. So when you’re investing in U.S. real estate, you have to figure out how to turn what's otherwise looked at as a passive investment into an active business. Each individual business needs to be actively involved and needs boots on the ground.
You need to be at least 50 percent owner in the company. You could create an investment company that could invest in different assets. But you have to show that you have boots on the ground, even if all you're really doing is acting as an equity partner.
Yes! Remember, it’s the tax implications on the Canadian side we’re worried about here. Again, the taxes will always outweigh the costs of additional structuring.
“If you end up becoming a U.S. resident then we can modify accordingly,” Lauren explains. But remember, getting a non-immigrant visa (which is one of the most common ways that Canadians access the U.S. market) does not require you to live in the U.S. You won’t necessarily become a U.S. taxpayer.
“But you have that flexibility to get a U.S. Social Security number, open a U.S. bank account, and build U.S. credit so there's a lot of advantages to getting this visa and as you're building your net worth and your portfolio in the U.S. it's it's it could be really advantageous.”
You're almost always selling the asset out of your entity because your entity actually has other things that are valuable in it. The entity will have the bank account and the credit history—things you'll want to retain even when you dispose a property. On the U.S. side of things, that allows you to be able to get access to business lines of credit after a year to two years.
Unless there's a good tax reason to sell the entity, you're almost always going to sell the asset and hold on to your entity.
You might be thinking this is too good to be true, and that’s exactly what you should feel when looking at advanced strategies.
“You're always going to think that when you're working with high-level professionals who are blowing your mind about what is actually possible and what best practices look like,” Scott says.
“This is all on the up-and-up. These are the best practices that we do for liability and tax protection at Royal Legal Solutions, and we've been doing it for over five years for over 2,000 investors.”
Royal Legal Solutions is on a mission to help people find financial freedom. Take our investor quiz and see how we can help you achieve your goals in U.S. real estate or wherever your path takes you. As investors ourselves, we take pride in setting you up for investment success. There is no good reason to take unnecessary risks with your hard-earned assets.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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