Canadians who own and transfer U.S. property in their lifetime or at death may face U.S. taxes. The first article in this 2-part series focused on U.S. estate tax. Our second article explores U.S. gift tax and how much some of your clients could expect to pay.
In the United States, a transfer of property from one person to another — whether or not the transfer is meant as a gift — may result in U.S. gift tax. And it doesn’t just apply to U.S. citizens and residents. Under U.S. law, anyone who owns and transfers ‘U.S. situs property’ in their lifetime, regardless of their residency or citizenship, may face a U.S. gift tax — including your clients.
For gift purposes, the definition of U.S. situs property includes real estate located in the U.S., such as a vacation home, and tangible assets located in the U.S., like a car licensed and garaged in the U.S. It doesn’t include intangible assets like U.S. stocks, bonds, mutual funds or bank, brokerage and trust accounts, even if the custodians for those assets and accounts are located in the U.S.
U.S. gift tax applies to:
- pure gifts (the giver receives nothing in return), and
- partial gifts (the giver receives something of less value than what they gave).
Fortunately, gift tax exemptions can offer some relief. To qualify for a gift tax exemption, gifts must be of a ‘present interest,’ meaning that the recipient has the right to access and use the gift immediately. From there, the exemption amount depends on who the recipient is:
- Gifts to a U.S. citizen spouse are exempt from U.S. gift taxes.
- In 2015, gifts to a non-U.S. citizen spouse are exempt up to the first $147,0001 annually.
- In 2015, gifts to anyone other than a spouse are exempt up to the first $14,000 annually.
Gifts of a future interest, which allow access only at a later date, aren’t eligible for gift tax exemptions.
Like U.S. estate tax rates, U.S. gift tax rates range from 18% to 40%. The top rate applies to gifts made during the giver’s lifetime of more than $1 million. The calculation of gift tax is cumulative, meaning that you must include prior year gifts in the tax calculation for current gifts, forcing the taxation of current and future gifts to occur at higher rates. Essentially, prior gifts permanently occupy the ‘lower rungs’ of the tax rate ladder, leaving only the higher rungs for current and future gifts. If the value of all the gifts someone makes in their lifetime exceeds $1 million, future gifts and any transfers at death will be taxed at 40%.
When a Canadian makes a gift of U.S. situs property with unrealized capital gains, differences in the Canadian and U.S. tax systems can result in double taxation.
Generally, under U.S. gift tax law, if someone gives property with unrealized capital gains, they don’t have to treat the gift as a disposition or include the capital gain in their income. Instead, the recipient acquires the property with the same adjusted cost base in the asset (so with the same latent capital gains tax liability) as the giver. If the recipient sells the asset, they pay capital gains tax on growth that occurred while they and the giver owned the gifted asset.
Canada, on the other hand, generally deems a gift to be a transfer that requires the giver to realize the capital gain on the asset when the gift is made. Because different people are paying capital gains tax at different times, there’s potential for double taxation on the part of the capital gain accumulated while the gift-giver owned the asset.
To address this, the Canada U.S. Tax Treaty (the Treaty) allows the giver to be treated as if they had sold and repurchased the asset just before giving it. This accelerates realization of the capital gain for U.S. tax purposes. It results in the giver having to pay U.S. and Canadian capital gains tax on the gains accumulated to the time the gift was made. But a Canadian taxpayer can use foreign tax credits to eliminate or reduce any double taxation that may result. When the recipient disposes of the asset, they pay capital gains tax only on the gains accumulated while they owned the asset.
However, there’s still a double tax issue which the Treaty doesn’t address. A giver could pay U.S. gift tax and Canadian capital gains tax without any foreign tax credit available to reduce the double taxation. The Treaty addresses this double tax issue in sections that deal with property transfers at death, but not during life.
For example: If a Canadian citizen/resident makes a gift of a U.S. situs capital asset that attracts U.S. gift tax, there is a potential double taxation problem. Under Canadian law, the transfer is a deemed disposition that requires half the capital gain to be included in the gift-giver’s income. But under U.S. law, the giver may owe gift tax on the transfer. The Treaty lets the gift-giver offset U.S. and Canadian capital gains tax, but doesn’t let them offset U.S. gift tax against Canadian capital gains tax. As a result, the gift-giver could pay two taxes on the same transaction — gift tax to the U.S. and capital gains tax to Canada. The only way to deal with the issue is through an exemption, as described earlier.
Awareness is key
If you have clients with U.S. assets, awareness is key. Encourage them to consult with cross-border tax or estate tax experts to learn more about U.S. gift tax and tax-saving strategies involving:
- structures to hold U.S. property,
- U.S. wills and powers of attorney, and
- life insurance.
For your information – U.S. taxes for Canadians with U.S. assets, a report published by Sun Life Financial (authored by Stuart L. Dollar, M.A., LL.B., CFP, CLU, ChFC, Director Tax and Insurance Planning, Sun Life Financial) in December 2014 offers more insight.
1 All amounts in this article are in U.S. dollars.