US substantial presence test for Canadians, especially snowbirds

Too much time in the sun could give you a taxburn

Okay, taxburn is not a real word … but it could be a real pain.

For generations, many senior Canadians have escaped northern winters by spending time in the sunbelt of the United States. As hospitable as our southern neighbours may be, if you overstay your allotted time you could find yourself in hot water.

That could mean being required to leave, being denied future entry, and being liable to
US income tax – or at least being required to file a US tax return – for the time you were there.

How long can you stay?

You may have heard the popular misconception that you can stay up to half a year in the US without tax consequences. While adequate as a guide for planning your seasonal apparel, if you get it wrong you could have some costly and complicated tax compliance ahead. Another variation is that you can stay in the US up to 182 days in a year; though this appears more precise, it too is misleading.

The substantial presence test

The starting point is whether you were physically in the US for at least 31 days in the current/calendar year, bearing in mind that a day is counted if you are present any time during the day. If so, then 182 days is the next critical marker, but not simply in reference to the current year (though that does matter if you need Canada-US Treaty relief, as noted further on), but whether you exceed that count in the three-part “substantial presence test” formula:

- Days in the current calendar year, plus
- 1/3 of the days in the first year before the current year, plus
- 1/6 of the days in the second year before the current year

In round figures, you will be onside if you consistently spend less than 120 days in the US annually, calculated as 120 + 40 [120/3] + 20 [120/6] =180. This is sometimes expressed as being about four months, but again be careful with such rules of thumb. Even two more days a year would take you to 122 days, causing you to fail the test within three years. That would be the case for example, if you make travel plans based on full calendar months, returning the last day of any month from June to January … and sometimes March, depending on when a leap year falls.

Excepted days and individuals

Fortunately, there are exceptions:

- Commuting from a Canadian or Mexican residence to a US workplace, if one is a regular commuter
- When in-transit for less than 24 hours when travelling between two places outside the US
- Crew of a foreign vessel that is in US territory
- When one is unable to leave the US due to a medical condition that developed while in the US
- Exempt individuals, such as foreign government employees, professional athletes participating in charitable events, and certain temporary teachers, trainees and students

Who’s watching?

At one time, individuals tracked and self-reported their days. Crossing records may have existed to verify or disprove arrival and departure, but there was no automatic/systematic oversight.

Today, the Canada Border Service Agency (CBSA) and US Customs and Border Protection (USCBP) agency track all individuals crossing the border, with relevant reciprocal data being shared between the agencies. Official records can be obtained from CBSA and USCBP through their respective ‘freedom of information’ request processes.

The USCBP also has an online quick-check service to see a screen view of an individual’s crossings over the preceding 10 years. Though not official, this can assist someone whose own records are incomplete, and is concerned about exposure to the substantial presence test. Further research may be undertaken as needed.

What if you exceed your days?

There are two categories of individuals presumptively subject to US income tax:

- US citizens wherever they reside in the world, and
- “Resident aliens”, being foreigners who are resident in the US

If you fail the substantial presence test, the US considers you to be a resident alien, potentially exposing you to US income tax on your worldwide income.

Relief under US domestic law

Most people can claim a closer connection to Canada to avoid that US liability. To do so, you must file IRS Form 8840 – Closer Connection Exception Statement for Aliens. In it you must confirm personal details “under penalty of perjury”, including the location of:

- Your permanent home
- Your family
- Your personal belongings, such as cars, furniture, clothing, and jewelry
- Your current social, political, cultural, or religious affiliations
- Your business activities
- The jurisdiction in which you hold a driver’s license
- The jurisdiction in which you vote, and
- Charitable organizations to which you contribute

Ideally the statement disclosure will be sufficient, but the IRS may demand supporting evidence, such as ownership records for your principal residence in Canada, your provincial driver’s licence or other official documents.

Relief under the Canada-US Treaty

The process may be more challenging if you exceed 182 days in a single calendar year. In that case, you will need to follow the procedure laid out in the Canada-US treaty. That can be more complicated and costly, and the IRS has more discretion to deny you in such cases, so it is best to steer clear of that if you can.

US real estate for Canadians

Buying, owning, renting and selling

Whether as sunny or snowy vacationers, dedicated urbanites or rural explorers, we Canadians spend a lot of time in the US – and that can also mean spending a lot of dollars. For those who are repeat renting visitors, the idea is bound to come up: Why not buy?

Real estate ownership is a big financial step, especially so if you’re thinking about distant property, with extra complexity when looking across the border into the United States.

This article identifies key tax and estate issues that Canadian would-be purchasers and existing titleholders should know when owning US real estate.

Being a non-resident buyer of US real estate

As a Canadian, you don’t require a special permit to own US real estate. Still, there are differences in how the real estate industry operates in the US, in particular how your legal rights are protected. In Canada, lawyers generally oversee the closing and title registration process, which may include obtaining title insurance. Comparatively, title insurance companies take the lead in many states, in place of some or all of what lawyers do here. It’s important for you to understand who represents you and how, before being marshalled through an unfamiliar system.

In a similar vein, you can obtain a mortgage from an American lender without having to jump over regulatory hurdles aimed at foreigners, but of course subject to the lender’s business criteria. Even so, you’ll need to allow more time for due diligence and preparation as compared to your familiar domestic Canadian deal. That’s because US lenders generally require more documentary disclosure, with added scrutiny when foreigners are involved. It will take time for you to understand, identify, collect and transmit documents (including Canadian credit score, income tax returns and relevant financial statements), and then for the lender to in turn verify, evaluate and approve before proceeding.

Who might hold title, and how?

As in Canada, US real estate may be owned individually, with others, or through another legal structure. Many of the same issues influence choices on either side of the border, with the added concern in the US about exposure to its Estate Tax. Though important to be aware of, a deceased foreigner’s worldwide assets would have to be worth over US$13 million in 2024 for any amount of such tax to be owing. For a deeper discussion of the US Estate Tax, see our article US Estate Tax & Estate Returns – For Canadians.

That aside, sole owners will probably register title directly in their own name, while spouses typically default to joint tenancy with right of survivorship (JTWROS), and multiple owners who are not spouses tend to prefer tenancy-in-common (TIC) whereby each maintains testamentary control of their proportionate interest. Though these are the common expectations, spouses could register TIC or in one name only, and non-spouses could choose JTWROS.
It is prudent to obtain independent legal advice as to the tax effects and succession rights under all options.

In terms of other legal structures, it is possible to use a corporation, trust or partnership, in all cases usually preferred to be resident in Canada, but possibly US resident. This extra layer adds legal complexity and maintenance costs, and possibly higher Canadian tax exposure. In most cases, the direct ownership options above will suffice, but a qualified professional can advise if there are exceptional reasons to proceed otherwise.

Revisiting ownership through a Canadian corporation or trust

Historically many Canadians used a sole-purpose corporation to hold US vacation property. However, in 2004 the Canada Revenue Agency (CRA) began imposing a taxable shareholder benefit for personal use of corporate property, which then swung the preference toward trusts over corporations when layered ownership was desired.

More recently as of June 25, 2024, both trusts and corporations face 2/3 income inclusion on all capital gains, while individuals can still use the 1/2 rate on up to $250,000 of capital gains in a year. This may influence toward holding title in personal name(s), given that large capital gains can arise on the eventual sale of real estate. Qualified cross-border legal and tax advice should be obtained before initiating or changing ownership registration.

US legal implications (or not) of ownership

In some countries, foreigners gain residential rights by purchasing land, for example the right to remain there longer than mere visitors. While there are occasional large-scale business incentive programs, there is no such rule in the US for personal-use real estate. And don’t be misled by rumours of favoured status being extended to ‘snowbird’ Canadians, as is recurringly speculated in popular and social media, but has never come close to legal reality.

For some comfort from the US tax perspective, one is not automatically required to file a US tax return just because US real estate is owned. However, annual US tax filing will usually be necessary when a property is rented, as well as when there is a disposition. Sometimes that is under your control, like when you choose to sell, but tax can also apply on a deemed disposition such as a gift of a property interest or upon an owner’s death.

Accounting for rental income

Again, one may be required to file an annual US tax return if rental income is earned, but not necessarily. First, there is an exception from filing if a US vacation property is rented for less than 15 days in a year. Beyond that, the US Internal Revenue Service (IRS) allows foreign owners to choose between two treatment options.

Option 1 – Gross rental income, without filing a US tax return

This is the simpler (though possibly more costly) option, whereby a 30% tax is paid on gross rental income, without having to file a US tax return. The tax is withheld by the tenant or by the foreign owner’s local property manager, and remitted directly to the IRS. Two forms must be filed annually, the first showing the arithmetic of the withholding tax calculation, and the second with further financial and personal information about the foreign owner(s):

- Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons
- Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding

As a Canadian resident subject to tax on worldwide income, the rental income would also be reported on your Canadian tax return. Deductions may be taken to arrive at the net rental income, against which a foreign tax credit (FTC) may be claimed, up to the lesser of US tax paid and the Canadian tax due on that US source income. Given the 30% US withholding rate on the gross rent, it is possible that some US tax would not be fully recovered.

Option 2 – Net rental income, requiring filing of a US tax return

Alternatively, one may report on a net rental income basis, effectively treating the activity as a business. This allows for the use of US graduated tax rates (rather than the flat 30% withholding rate) applied on net income after deductions. Many deductions will be the same in both countries, like utilities, property tax and management fees. But the systems also diverge in key respects, such as mandatory depreciation claim in the US (elective in Canada), broader mortgage interest deductibility in the US, and differing approaches to rental losses. These differences can lead to mismatched type and timing of deductions, so be sure that your Canadian and US professionals are coordinated.

Despite the accounting challenges, the net option will likely reduce the US tax liability, while concurrently increasing the likelihood of fully utilizing the FTC on your Canadian tax return. To file a US non-resident tax return, one must first have an individual taxpayer identification number (ITIN), similar to a social insurance number (SIN) for Canadian domestic tax filing. In sequence, the forms are:

- Form W-7, Application for IRS Individual Taxpayer Identification Number – The IRS processing time to issue an ITIN is about 7 weeks, or 11 weeks at peak times (January-April) or when applying from abroad.
- 1040-NR, U.S. Nonresident Alien Income Tax Return – For annual income tax reporting. If only reporting rental income (technically part of “income effectively connected with US trade or business”), the due date is June 15^th following the taxation year, or the next business day if that is on a weekend. If other income is being reported, the filing due date may instead be April 15^th. Confirm with a US tax professional.

The tenant would need to be given an official release so that the otherwise 30% is not withheld from rent. This is achieved by providing the tenant a Form W-8ECI Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States. This form is not sent to the IRS, but
Form 1042 and Form 1042-S must still be filed, either by you or your property manager if you employ one.

Importantly, once the election is made to use net reporting, it applies to all US real estate owned, and to the current and all future tax years. The only way to revoke that is with consent from the IRS, which is infrequently granted. With this in mind, some people may be content to use the gross method as a new owner (if the expected cost difference is not too steep), thereby preserving the flexibility to change to the net method in future if it better suits their evolved needs.

Selling US real estate

When it comes time to move on from owning that US property, there are three main tax issues to address:

- US withholding tax
- US income tax reporting as a non-resident
- Canadian income tax reporting

US withholding tax

A purchaser/transferee of US real estate from a foreign owner is obliged to withhold 15% of the proceeds and remit it to the IRS. There are two forms for this purpose:

- Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests
- Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests

Form 8288 accompanies and provides the arithmetic of the withheld tax, being due by the 20^th day after closing, with interest and penalties imposed on the purchaser if it is late. A Form 8288-A must be included for each transferor/seller, a stamped copy of which will be sent by the IRS to each transferor to be attached to their US tax return to receive credit for any tax withheld. Following here are the three most common exceptions to the withholding requirement when a non-resident individual disposes of US real estate.

Exception 1 – Sales price below US$300,000, and future use as a residence

No withholding is required if the purchaser acquires the property as a residence and the sales price is below US$300,000. The buyer or a family member must have definite plans to reside at the property for at least 50% of the days the property is used by any person during each of the first two 12-month periods following the closing date.

Exception 2 – Sales price from US$300,000 to $US 1 million, and future use as a residence

If the purchaser acquires the property as a residence as outlined above, and the sales price is no more than
US$1 million, withholding is still required, but at a reduced 10% rate.

Exception 3 – Withheld amount exceeds the transferor’s tax liability

If you as seller expect your US income tax liability on the capital gain to be less than the withholding rate, you can apply to the IRS for reduced withholding. To release the purchaser from the withholding obligation, a withholding certificate must be in-hand prior to closing. The seller/transferor applies for this using Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests. According to the form instructions, the IRS will normally act on an application by the 90th day after a complete application is received.

US income tax reporting as a non-resident

As on the advice side before taking action, it is highly recommended to hire qualified US tax advisors when it comes to fulfilling reporting/compliance tasks. The sale of US real estate by a non-resident owner is complex and beyond the scope of this article, so just briefly here are some ways the proceeds of sale may be treated for US reporting:

Adjusted cost basis (ACB) – This is what the owner originally paid for the property, less costs of acquisition & disposition and periodic depreciation claims, plus costs for capital improvements – Non-taxable

Long-term capital gains – The difference between sale proceeds and ACB is a capital gain (subject to recapture of deductions as discussed further on) – Currently taxed at 0%, 15% or 20%, depending on income level

Short-term capital gains – When capital property is held for less than 12 months, the capital gain component of the sale proceeds is taxed as regular income – Graduated tax rates between 10% and 37%

Recaptured depreciation – Cumulative deducted/claimed depreciation (mandatory under net rental income option) is re-included in income, before any capital gain is determined – Graduated tax rates between 10% and 37%

Unrecaptured section 1250 gain – An adjustment to recapture when an accelerated depreciation method has been used, above what would apply using a straight-line method – Usually at a 25% maximum tax rate

Principal residence for US tax purposes

Up to US$250,000 of capital gains may be excluded from tax on sale of a principal residence. The property must have been used a primary residence for at least 2 of the 5 years prior to sale. As it must also be the owner’s ‘main’ home, it is possible but unlikely for this last requirement to apply for a Canadian who uses it as a vacation home.

Canadian income tax reporting

Recapture and capital gains on sale

To the extent that depreciation (technically capital cost allowance) has been claimed in annual tax reporting, the cost base of capital property is reduced. When sale proceeds are more than the undepreciated cost, there will be fully taxable recapture until exhausted, and capital gains above that. As noted earlier, as of June 25, 2024, trusts and corporations face 2/3 income inclusion on all capital gains, while individuals can use the 1/2 rate on up to $250,000 of capital gains in a year, with the 2/3 inclusion rate applying above that.

Principal residence exemption

The Canadian principal residence exemption (PRE) may be used to reduce or eliminate the capital gain on sale of a residence, whether in Canada or elsewhere. A property qualifies if it is ordinarily inhabited, but does not have to be one’s main home as required under US rules. If the PRE is claimed for Canadian reporting only, any US tax will not be available as a foreign tax credit, as there is no corresponding Canadian tax against which the FTC may be claimed. Alternatively, a sufficient number of years could be claimed to offset the FTC, leaving unused years available for future use of the PRE against other concurrently owned property.

Canadian T1135 foreign income verification

T1135 reporting may be required if one holds foreign property with a cost in excess of C$100,000. This would apply to outright investment property or even to a periodic vacation home that is rented most of the time. To be clear, this is an information reporting form to accompany one’s annual tax return, not an additional tax. Effectively it apprises the CRA that certain property exists, providing a paper trail to track eventual disposition and capital gain reporting.

Currency exchange rates

Apart from day-to-day cash needs when spending time at one’s property in the US, both the US and Canada require tax reporting and tax payments to be in their own currency. Canadians with US property will have to establish a banking relationship in the US, and/or be ready to engage in foreign exchange, wire transfers and cross-border online banking so that US currency is available for both small and large cash needs.

Beyond that, the movement of the exchange rate between the currencies can complicate tax reporting. For example, if the US property value drops while the US dollar rises against the Canadian dollar, a later sale could result in a capital gain in Canada and a capital loss in the US. It can get even more complicated depending on the nature of the property (eg., investment or personal use), distinctive or conflicting definitions, and differences in how tax credits and losses are handled.

Estate planning with cross-border assets

When real estate is owned in another jurisdiction, it is important to take appropriate steps to assure that the property is covered in one’s estate planning. This is true even when looking at provincial borders, and most certainly needed when international borders are involved. If one dies, a home province Will may ultimately have legal authority to deal with assets elsewhere, but it can be costly and time-consuming to re-seal/approve it through the courts and legal process of another jurisdiction.

A common recommendation is to execute a Will and Powers of Attorney (both property and personal care) under the guidance of a lawyer in a foreign jurisdiction where real estate is owned. By coordinating with the home jurisdiction lawyer, the foreign documents can be drafted so they are constrained to the subject property and jurisdiction, so as not to alter or revoke the core jurisdiction documents. At such time as it may be necessary for them to take effect, there will then be an existing relationship with a local professional who can advise and assist as required.

US estate tax & estate returns – For Canadians

Exposure when owning American property at death

As Canadians, we may expect (though not look forward to) tax being imposed on us by our government at death. In particular, the value of tax-sheltered retirement accounts is brought into income at death, as are the capital gains on the deemed disposition of capital assets – both of which may be deferred by transfer/rollover to a spouse or common law partner (CLP).

For those owning property in the United States at death – ranging from real estate to financial assets to personal belongings – there may be US Estate Tax due (capitalized in this article to distinguish from generic tax references), and US estate filing obligations even if no such tax is owed. The tax is based on gross value, not just the capital gain that Canada targets, and even when there is a rollover to a Canadian spouse/CLP. As well, US financial assets are counted whether in non-registered form or in tax-sheltered accounts like RRSP/RRIFs and TFSAs.

Whether you are pre-planning against your own future exposure, or acting post-mortem as an executor, professional advice is imperative in this extremely complex area. This article outlines the key terms and major steps involved, to help prepare for that professional engagement.

Who is exposed to the Estate Tax?

This article focuses on the tax and estate implications for Canadians who own US property at death, with emphasis on the Estate Tax. To lay the groundwork, we begin with an overview of how that regime applies to Americans domestically, paving the way for the discussion of its application to Canadians that follows.

US citizens and domicilliaries

The Estate Tax applies to the worldwide estate at death of US citizens wherever they may be living, and of
non-citizens domiciled in the US. Domicile is like residence, though technically based on a person’s country ties.

If the fair market value (FMV) of a deceased’s worldwide estate exceeds the year’s asset exclusion amount – US$13.16 million in 2024 – tax may be due on the amount over that threshold. Historical exclusion amounts are shown in Table 1 on the last page of this article. Though the table shows increasing amounts year-to-year, it is slated to return to its pre-2018 indexation formula in 2026 (roughly halved to about US$7 million), absent further legislative changes.

Credits and deductions are then applied to reduce this preliminary figure to the amount upon which the tax is calculated, applying graduated rates ranging from 18% to 40% as shown in Table 2 on the last page of this article.

In addition, the US has a gift tax and generation-skipping transfer tax (GSTT). The gift tax applies to lifetime transfers above an annual exclusion amount per donee, currently US$18,000 in 2024. The GSTT limits transfers to beneficiaries at least two generations younger than the donor/giver. Without getting into the arithmetic, to the extent that the gift tax and/or GSTT apply during lifetime, this can erode the asset exclusion amount for the Estate Tax.

One important note before continuing: Though the rules and figures are expressed on an individual basis, there are plenty of ways to defer, deduct and double-up when planning with a spouse. Professional advice is recommended.

US non-residents, including Canadians

Relevant to this article, the Estate Tax can also apply to a deceased Canadian who is a non-resident of the US, if:

1. FMV of the deceased’s US-situs assets (detailed following) exceeds US$60,000, and
2. FMV of the deceased’s worldwide estate exceeds the current year’s exclusion, again US$13.16 million in 2024.

However, whereas US citizens and domiciliaries pay based on the full FMV above the exclusion, the calculation for a non-resident Canadian is a proration of US-situs assets to the worldwide estate (again, above the exclusion).

Threshold and deadlines for filing a US estate return, and paying Estate Tax

The executor of a deceased Canadian must be careful not to confuse the test for the Estate Tax with the test for the requirement to file a US estate return. If a deceased Canadian owned US-situs assets in excess of US$60,000 at death, an estate return must be filed with the US Internal Revenue Service (IRS), regardless of the size of the estate. Generally, the executor must include a certified copy of the Will or court order when filing.

The IRS clearance certificate facilitates the executor’s ability to deal with estate assets. Without that proof, financial institutions may refuse to take instructions from the executor, and US real estate transfer agents may be unwilling to register an intended transaction. As well, the estate’s reporting provides the tax cost basis for heirs’ future real estate dealings, without which they may face higher tax on a later sale, or may not be able to sell the property at all.

Important deadlines for executors:

- A US estate return is due within nine months of death, along with payment of the Estate Tax. A six-month filing extension is generally granted if application is made before the due date.
- Extension of the Estate Tax payment due date is distinct from an estate return extension. Executors must be aware that while this will avoid late payment penalties, interest will accrue from the original due date.

Categorizing assets

US-situs assets

The IRS defines “situs” as “The place to which, for purposes of legal jurisdiction or taxation, a property belongs.” Though a non-exhaustive list, here are some examples of the most common US-situs assets, also phrased as “US-situated assets” in some IRS publications:

- Real estate (including time-shares), generally being the full value even if held jointly with right of survivorship
- Tangible personal property (furnishings, vehicles, boats, art, collectibles) owned and located in the US
- Shares of US corporations (public or private), even in a Canadian brokerage account or registered account
- Bonds and debt issued/owing from a US individual, corporation or government
- US retirement plans, common types being 401K and 403B plans, and individual retirement accounts (IRAs)
- Contents of a safety deposit box in the US, including cash, regardless of currency/country of denomination
- US property held in a trust if the deceased had power of appointment, including an alter ego or joint partner trust

NOT US-situs assets

Some financial assets may have US elements, but due to their underlying structure or the way that ownership is held, they are not considered to be US-situs assets. Some examples, again non-exhaustive:

- US securities in a Canadian mutual fund trust or corporation, segregated fund or exchange-traded fund (ETF)
- Personal property that is merely in-transit, for example jewellery worn by a Canadian who dies while travelling
- US marketable securities or investment real estate held in a Canadian corporation, noting however that vacation property may come under IRS scrutiny for avoidance, especially if it is the corporation’s only asset
- American depository receipts (ADRs), as they do not hold US securities
- Deposits in a US bank account (but not US brokerage account), as long as it’s not part of a US business activity
- Excepted US government and corporate bonds under the “portfolio interest exemption”
- US-denominated bonds of a Canadian issuer providing US exposure without holding US securities
- Life insurance on a Canadian who is a US non-citizen/non-resident

Worldwide estate

A deceased’s worldwide estate is determined according to US rules, whether the property is in the US, Canada or elsewhere. This may include assets of significant value, about which careful decisions and actions may have been taken to alleviate or circumvent Canadian income tax or provincial succession issues, but which nonetheless remain countable for the Estate Tax, including:

- Canadian registered plans, including RESPs, RDSPs, TFSAs, RRSPs, RRIFs, and survivor pension benefits
- Life insurance owned by the deceased (or sometimes a deceased’s corporation), even with a named beneficiary
- FMV of private corporation shares, after payment of a death benefit from corporate-owned life insurance
- Gross value of real estate and non-registered accounts, even when held jointly with right of survivorship
  (with limited exception if the survivor is a spouse with a proven contribution to the asset acquisition)
- Property in a trust considered to be a US grantor trust, likely capturing a Canadian alter ego or joint partner trust

Tax calculation

Once it is determined that a deceased Canadian meets the threshold of both US-situs assets and worldwide estate, attention may turn to calculating the tax liability. The calculation begins with the gross value of the US-situs assets.

Deductions

A variety of deductions and credits may be taken, most of which must be prorated based on the proportion of US-situs assets to worldwide assets. The main deductions are:

- Funeral and estate administration expenses
- Liabilities of the deceased at or as a result of death, including foreign (i.e., Canadian) income tax
- Death taxes paid to a US state
- Charitable donations (generally must be made to a US entity, with payment made in the US)
- Non-recourse debt on US property (i.e., lender’s claim is limited to the pledged asset) – Fully deductible.

Taxable estate

The deductions are applied against the gross US-situs assets to arrive at the taxable estate. This figure is then used to calculate the preliminary Estate Tax amount by applying the graduated rates in Table 2.

Unified credit

Any deceased who is a non-resident and non-citizen of the US may apply the unified credit against the calculated preliminary Estate Tax. The minimum unified credit is US$13,000, which is equivalent to the Estate Tax on an estate of exactly US$60,000, as can be verified by viewing columns [A] and [C] on Table 2.

Alternatively, the executor may claim the unified credit under the Canada-US Tax Convention (the “Treaty”), which allows Canadian residents to claim the same as is available to a US citizen or domiciliary – US$5,389,800 in 2024, equal to the tax on a US$13.16 million estate – as can be verified by viewing the first row on Table 1. This is then prorated based on the proportion of US-situs assets to worldwide assets.

Thus, the formula for a Canadian resident is:

Marital credit

The Treaty allows a marital credit for property passing to a Canadian or US resident spouse who is a non-US citizen. It is restricted to legally married spouses as defined under US law. The credit is equal to the lesser of the prorated unified credit and the Estate Tax payable on US-situs assets transferred to the spouse. The net result is that it can effectively double the prorated unified credit.

Canadian federal tax credit for US Estate Tax paid

As noted in the introductory paragraph of this article, Canadian tax law deems capital property to be disposed upon death. This applies to the worldwide assets of a Canadian resident, including US-situs property. As of June 25, 2024, a 1/2 capital gains inclusion rate applies to the first CA$250,000 of capital gains in a year, with 2/3 inclusion applying to capital gains above that threshold. The included amount, or “taxable capital gain” is added to the taxpayer’s income for the year. When a person dies, the terminal taxation year is January 1^st to the date of death.

Under the Treaty, a foreign tax credit may be claimed against Canadian federal tax related to US-situs property.
The credit is limited to the Canadian tax liability on that property, noting that there is no terminal year tax on RRSP/RRIF accounts (including any US-situs investments therein) rolled to a surviving spouse.

At present, no province or territory allows a foreign tax credit for the Estate Tax.

Planning options to limit Estate Tax

There are both simple steps and complex strategies that can be taken to reduce Estate Tax exposure. Each has its costs, benefits and drawbacks, with some able to be used in combination, and some mutually exclusive of others. Following here are some approaches that can be explored more deeply with a qualified cross-border professional.

Lifetime gifting or selling

If a given property is not owned at death, then the Estate Tax will not apply, at least not directly. Depending on when and to whom assets are transferred, gifting could affect the eventual exclusion amount available at death. The other immediate consequence to consider is early realization of capital gains that would otherwise be deferred until death.

Relocating property out of the US

Vehicles, jewellery, artwork, collectibles and other personal belongings are considered US-situs property if housed in the US. It may be preferable to transport any such property back to Canada if not required for current living needs.

Choosing/changing form of investments

While US securities are US-situs property, there are ways to have US market exposure that still shields against Estate Tax. One of the simplest ways is to own US mandates in Canadian mutual funds, segregated funds or ETFs. Large accounts can command fees comparable to individual security portfolios, so cost is not a material issue.

Life insurance, with or without an ILIT

Assuming an adequately healthy person, life insurance can provide liquidity to pay the Estate Tax. Unfortunately, the death benefit will be included in the worldwide estate if owned by that person. Alternative owners could be another person or an irrevocable life insurance trust (ILIT). In the latter case, it is best to have the ILIT acquire the policy from the outset, as there is a lookback attribution to that person if transferred within three years of death.

Non-recourse mortgage financing

Non-recourse debt is fully deductible against US-situs assets without proration based on one’s worldwide estate.
As enforcement is limited to the property being mortgaged, it may be difficult to source a willing lender. Additionally, such arrangements inevitably have higher interest charges and other potentially onerous covenants.

Canadian holding corporation

Assets held in a Canadian corporation will not be subject to the Estate Tax. While beneficial on its own, this must be balanced with the Canadian corporate tax treatment, particularly in light of the increased 2/3 capital gains inclusion rate for corporations as of June 25, 2024. As well, if residential/vacation property is held in a corporation, its use by a shareholder or other non-arm’s length individuals will likely be treated as a taxable shareholder benefit.

Canadian discretionary trust

A trust may be preferable to a corporation for either or both investment holdings and vacation property. Though trusts are taxed at the highest bracket rate (including that they too now face the 2/3 inclusion rate on capital gains), they can often be drafted such that income is allocated to one or more beneficiaries. For vacation property, the terms can allow for its use by a wide range of beneficiaries, and there is no corresponding concern like shareholder benefits with corporations. As trusts are subject to deemed disposition of capital assets every 21 years, periodic monitoring and occasional adjustment or distributions may be necessary.

Distinguishing US and non-US gift recipients

Whether giving in life or at death, it may make things more manageable for the next generation if you isolate or skew the allocation of US-situs property to US persons only. They will have to grapple with US succession rules on all their assets anyway, whereas non-residents will only be exposed if they hold US-situs assets.

US dynasty trust

If you expect one or more of your beneficiaries to remain permanently in the US, an irrevocable dynasty trust may be worth considering. If drafted in accordance with US law, it can minimize the impact of the Estate Tax, gift tax and GSTT, and as a US resident trust it is not subject to the 21-year deemed disposition of capital property.