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The Enhanced U.S. Estate Tax Credit Provides Canadians Increased Opportunities to Own U.S. Real Estate and Assets

February 3, 2014
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For at least the reasonably foreseeable future, the “American Taxpayers Relief Act of 2012” (the “2012 Act”) ended the eleven-year saga in which the U.S. estate tax provisions changed almost annually, often dramatically.

In that period, the estate tax rate ranged between 55% and zero (in 2010 when the estate tax was eliminated for the year). The amount of the personal exemption available in that period ranged from $1,000,000 to $5,000,000, at times “yo-yoing” from year to year.

The 2012 Act set the estate tax rates at 40% at a maximum and the amount of the exemption at $5,000,000, indexed for inflation. In 2014, the exemption amount is $5,340,000.

The Unified Credit Available to
Canadians

Non-U.S. citizens are subject to U.S. estate tax on their U.S. situs assets, such as U.S. stocks and real estate. Foreign owners are provided an exemption of up to $60,000 for those assets, which equates to a $13,000 estate tax credit.

Unlike other foreign owners of U.S. assets, however, Canadians are not limited to the $60,000 exemption/$13,000 credit.

The Canada-U.S. Income Tax Treaty (“Treaty”), allows Canadians a portion of the $5,000,000 U.S. personal exemption or a “unified credit” of $1,945,800. This exemption is called an “enhanced credit” and is computed as the percentage of a Canadian’s worldwide assets that are U.S. assets multiplied by the amount of the current “unified credit” under U.S. law.

The 2014 estate tax exemption of $5,340,000 translates into a maximum “enhanced credit” for Canadians of $2,081,800. The amount of such maximum “enhanced credit” to which an individual Canadian’s estate is entitled is computed as follows:

             Value of Canadian’s U.S. Situs Assets  x $2,081,800
             Value of Canadian’s Worldwide Assets

In addition, if the deceased Canadian’s U.S. situs property is left to his or her surviving spouse, the Treaty also provides for a “marital credit” equal to the amount of the above prorated “enhanced credit”.

How this works is perhaps best illustrated by an example. Assume that Mr. and Mrs. Miller reside in Ontario, that both are non-residents of the U.S. and that he has worldwide assets with a gross value of $10,000,000, including a ski chalet in Ellicottville, New York and a condominium in Ft. Myers, Florida that have an aggregate value of $1,500,000.

Upon Mr. Miller’s leaving the U.S. properties to his wife on his death in 2014, the U.S. estate tax (based upon the current marginal rates) would be $545,800. Since Mr. Miller’s U.S. assets comprise 15% of his worldwide assets, his estate can claim a U.S. unified credit of $312,150 (i.e., 15% of the $2,081,800 unified credit) and also a marital credit of $312,150. 

In this example, the total of the two credits exceed the amount of the U.S. estate tax, and no U.S. estate tax would be owing.

Assuming further that Mrs. Miller was the beneficiary of all of Mr. Miller’s assets and that she had no other assets of her own, upon her later demise in 2014 there would be a U.S. estate tax owing of $233,650, computed as follows:

$545,800 as the estate tax on the $1,500,000 of the U.S. situs assets (again based upon current marginal rates), less a $312,150 “unified credit” (again 15% of the maximum $2,081,800 unified credit).

If we alternatively assume that the value of Mr. Miller’s worldwide assets was $6,000,000 and his U.S. assets had a value of $750,000, his “enhanced credit” would be $260,225. The gross U.S. estate tax would then be $248,300 and his net U.S. estate tax would then be zero.

Ancillary Administration Still an Issue

The increase in the U.S. estate tax personal exemption enables Canadians to own U.S. property of a larger value without being subject to estate tax. The estates of Canadians owning U.S. real property however will incur the costs of ancillary administration proceedings in the U.S.

When a person owning real property in the U.S. in his/her name alone passes, title to the property can be transferred to the person’s heirs only through an estate proceeding.

Estate proceedings in the decedent’s place of domicile (presumably Canada for Canadians) occur first. Once those proceedings are initiated, ancillary proceedings would take place in the state in which the property is located.

In the above example, ancillary proceedings would be required in both Cattaraugus County, New York and Lee County, Florida given Mr. Miller’s properties located there.

Those proceedings would typically cost at least $4,000 - $7,000 in each jurisdiction.

One alternative that would avoid needing to bring ancillary proceedings would be to have the U.S. real property owned by a U.S. revocable living trust (in the Millers’ case this would be a New York and/or Florida trust).

A revocable living trust is a separate legal entity for title purposes, but is a disregarded entity for U.S. income and estate tax purposes.

Upon the demise of the creator(s) of such a trust, title to trust property passes to the named beneficiaries as provided in the trust agreement, without a need for ancillary administration.

Summary

Canadians have increased opportunities to own U.S. real estate as a result of the 2012 Act since the U.S. estate tax exemption has increased from $1,000,000 (corresponding to a unified credit of only $345,800) to $5,340,000 (with a corresponding unified credit of $2,081,800) in 2014.

As a result, Canadians can own U.S. property of a substantially increased value without having U.S. estate tax exposure.

Nevertheless, avoiding the hassles and the expense of ancillary administration is often alone enough of a reason for Canadians not to take title to U.S. real estate individually.

Using a revocable living trust may provide Canadians owning U.S. properties a way of avoiding the time and expense of ancillary administration.