A growing number of Canadians are getting into the U.S. real estate investment game.
According to the National Association of Realtors, Canadian buyers spent $9.5 billion on U.S. residential property purchases during the 12-month period between April 2019 and March 2020. This means that Canada only trails China in the worldwide rankings of foreign investments in U.S. real estate by country.
As more and more Canadians look to acquire U.S. properties, investors must keep in mind the tax implications of purchasing real estate in one country while living in another.
In this article, we’ll explain the ins and outs of how Canadians are taxed if they invest or do business in the States and how you can avoid double taxation.
We usually recommend that our clients in the States use a Limited Liability Company (LLC) to manage their real estate investments. Not only do LLCs protect investors from personal liability, but they also offer tax advantages compared to a corporation, allowing owners to avoid double taxation on their business’ profits.
Under U.S. law, corporations are taxed on their profits, and then employees and shareholders are taxed personally on the income they receive from the business. This means that every dollar the business makes is taxed twice. With LLCs, the business is not taxed separately. Instead, all of the business’s profits are reported as individual income of the LLC’s owners. This is known as pass-through or flow-through taxation.
Unfortunately, both single and multi-member U.S. LLCs are recognized as foreign corporations under Canadian tax law. So, if a Canadian invests through a U.S. LLC, the LLC distributions would be considered foreign income that is not subject to a Canadian dividend tax credit or a foreign tax credit. Rather, LLC income will be subjected to double taxation, eliminating the benefits of pass-through taxation that make LLCs ideal for investors in the states.
For this reason, Canadian investors had traditionally relied on U.S. limited liability limited partnerships (LLLPs) and U.S. limited liability partnerships (LLPs) when investing in the States. Historically, these structures had been viewed as partnerships for Canadian tax purposes and therefore allowed investors to avoid double taxation.
However, in 2016, the Canada Revenue Agency (CRA) announced that going forward, U.S. LLLPs and LLPs would be classified as corporations rather than partnerships. This may mean double taxation for Canadian investors who manage their U.S. investments through LLLPs or LLPs.
Now that LLLPs and LLPs are treated as corporations, the ideal structure for Canadian investors is a U.S. Limited Partnership (LP) structure. Similar to how LLCs work for American investors, LP income is not taxed at the corporate level; it’s passed through and reported on its owners’ personal income tax returns.
Plus, LPs offer Canadian limited partners comparable personal liability protections to LLCs without the double taxation that comes with investing in a U.S. LLC. It’s a win-win!
As you can see, intercountry taxation issues can be messy and complicated. In order to enjoy the tax advantages available through U.S. LPs, Canadians must ensure that the required documentation is drafted and filed correctly. Mistakes could result in substantial tax penalties, forfeiting your liability protections, or even losing your right to do business in the U.S.
For this reason, Canadians who are thinking about purchasing properties in the States should consult with a U.S.-based business attorney with experience in real estate investments before making any purchases. A U.S. lawyer can help you minimize your taxes and maximize your profits.
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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