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Estate planning for Canadians investing in U.S. vacation homes.

Many Canadians buy U.S. vacation homes to escape to a warmer climate during the winter. As a result of owning real property in the United States, these individuals must concern themselves with the manner in which the United States imposes taxes, especially on a decedent's estate. (See the Tax Clinic item, "Estate Planning. for Nonresident Aliens After TAMRA," TTA, May 198, at 337.)

No marital deduction is allowed for estate tax purpose if the surviving spouse is not a U.S. citizen, unless the property passes to a qualified domestic trust (Secs. 2056(d) and 2056A). Also, estate of nonresident aliens (NRAs) are subject to tax on U.S. property at the same rates as those imposed on U.S. citizens or residents. A U.S. citizen or resident is entitled to an estate tax credit equivalent to the tax on the first $600,000 of his taxable estate while an NRA subject to U.S. estate tax is only entitled to a credit equivalent to the first $60,000 of this U.S. taxable estate (Sec. 2102(c)(1)). Estates are taxed at graduated rates with a top rate of 55% through 1992 and 50% thereafter. There is also a 5% surtax on certain large estates to phase out the benefit of the graduated rates and the credit previously described.

Example: C, a Canadian, owns a condominium worth $200,000 in Florida. This is C's only U.S. asset. When C dies, the real property will be included in his U.S. gross estate, and will result in $41,800 U.S. estate tax (approximately 21% of the property's value). This tax is not available as a credit against any Canadian taxes because there is no Canadian/U.S. estate tax treaty provision providing such relief.

The following points should be considered.

* The NRA can purchase the U.S. property with nonrecourse debt that will be deductible for U.S. purposes.

* The NRA can purchase life insurance equal to the expected U.S. tax. However, the insurance's cost should be compared with the benefits to be derived.

* The NRA can dispose of the property before death. However, a U.S. income tax may be incurred on the disposition.

* The NRA can form a Canadian corporation to own the U.S. real property, since a foreign corporation's stock owned by an NRA is not subject to U.S. estate tax (Sec. 2104(a)).

Canadians must be careful when using a corporation to hold investments in real estate if they have control and/or enjoyment of the underlying property. Problems can arise from shareholder benefits, such as the shareholder not paying rent. However, Revenue Canada has authorized the use of a special type of Canadian corporation called a single-purpose corporation for this type of situation.

There are no adverse Canadian tax effects to the shareholder as a result of shareholder benefits with this type of corporation. To avoid Canadian tax problems and qualify as a single-purpose corporation, the following requirements must be strictly adhered to.

* The corporation's only objective must be to hold a home for the shareholder's personal use.

* The corporation's only transactions must relate to holding the property for the shareholder's personal use.

* The shareholder must advance ot transfer all funds to the corporation to pay for the property.

* The corporation's shares must be held by either the individual or by related parties.

To ensure that a single-purpose corporation is treated as a corporation by the Service, it is important that the corporate form be respected by both the shareholder and outsiders. The following steps should be taken to establish the corporation as a separate entity for U.S. tax purposes.

* The corporation should be properly incorporated and comply with the requirements of both Canada and the specific province within which it is formed.

* The shareholder should transfer cash or property to the corporation in exchange for shares of stock. The corporation should make sure that stock certificates are issued to the shareholder and noted in the corporate records.

* The corporation should hold meetings of the board of directors and/or stockholders on an annual basis and maintain the meetings' minutes with the corporate records.

* The corporation should properly register to do business in the state in which the property is located and arrange to have a registered agent located in that state, if required by local law. (Florida, for instance, has such a requirement.)

* All appropriate income tax returns should be filed with Revenue Canada, the IRS and the state in which the property is located.

* Title to the property should be held in the corporate (and not in the shareholder's) name. In addition, any mortgages for which the property serves as collateral should be in the corporation's name, with the shareholder servicing only as guarantor if required by the creditor.

One individual should be specifically authorized to act on the corporation's behalf, thereby providing centralized management. The corporation's articles of incorporation or by laws should state that the corporation's life will be indefinite, without regard to the death or withdrawal of any shareholder (Regs. Sec. 301.7701-2(a)).

A Canadian single-purpose corporation formed to hold U.S. property is not without risk. The Service might attempt to disregard the corporation's existence and include the U.S. real property in the NRA's gross estate. However, implementing these suggestions should strengthen the argument that the corporation exists separately from its shareholder. Of course, U.S. income tax considerations must also be taken into account.

From Richard G. Wolfish, CPA, Miami, Fla., and Daniel Dominguez, Sr., CPA, Houston, Tex.
COPYRIGHT 1992 American Institute of CPA's
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Article Details
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Author:Dominguez, Daniel
Publication:The Tax Adviser
Date:May 1, 1992
Previous Article:IRS relaxes requirement that most payments to related foreign entities may be deducted only when paid.
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