Have you ever caught yourself daydreaming about owning a pied-à-terre in an old-world metropolis, or a piece of tropical paradise? While international property ownership can be a pleasing fantasy, careful planning and understanding of the tax and estate concerns can prevent those reveries from becoming a nightmare. Here’s what to think about before clients buy in a foreign market.
Research local issues
International real estate should not be an impulse buy. Make sure clients look into foreign property ownership restrictions and taxes, the political climate and the process for buying and selling real estate.
Currency can play a big role in these transactions. In addition to exchange rates, clients should consider currency restrictions once they sell the property and try to bring the proceeds back to Canada. There may also be historical restrictions on a property that limit renovations and future development, and buyers will want to consider the costs of security, transportation and hooking up to utilities. One way to research such granular details is to spend time living in the country by renting property, rather than staying at a hotel or resort.
Purchasing property does not have immediate income tax implications in Canada. However, depending on the intended usage, a client may be required to disclose the property on Form T1135. CRA identifies three possible scenarios for a foreign vacation property:
- exclusive use as a vacation property;
- renting out the property more than 50% of the time over the course of a year with a reasonable expectation of profit; and
- renting the property part of the year with the intent of recovering associated ownership costs, rather than an expectation of profit.
Usage under scenarios #1 and #3 would not need to be reported on the T1135. In #2, the property is not considered personal use property since it is being rented out more than 50% of the time. Under these circumstances, if the adjusted cost base of this property and any other specified foreign property is $100,000 or more at any point in the year, it must be reported on the T1135. Don’t forget other specified foreign property that might need to be included on the T1135 that could be indirectly related to property ownership (e.g., foreign bank and investment accounts). Currency fluctuations may also push your client above the threshold, making it necessary to report on the T1135 even if the cost amount is back under $100,000 by the end of the year.
In terms of foreign income, rental income would be taxable. Clients must report gross rental income and can deduct expenses related to that rental income, resulting in only the net rental income being taxable.
Since the rental income is earned in another country, it may be taxable there, too. Some governments require that tax be witheld at source on those rental payments. It will be important to review these requirements and any documentation or process that may allow clients to avoid such withholding tax. Foreign tax paid may be eligible for a credit against Canadian taxes owing on the same rental income.
When clients sell property, any capital gain is taxable for Canadian tax purposes. It may also be taxable in the country where the property is domiciled. Not all countries tax capital gains in the same manner as Canada, but a foreign tax credit may be available to offset some or all of the Canadian taxes on the capital gain.
Canada’s principal residence exemption (PRE) can be applied to real property located outside of Canada to protect the capital gains upon sale from Canadian taxation. Applying the PRE to foreign property would not allow the PRE to be applied to any other real property owned by the same person (and/or their spouse or common-law partner) for the same period. Further, the PRE is not available to trusts that own real estate except under specific conditions.
How to own the property
Before clients purchase vacation property, they should consider how they’ll set up legal ownership.
- Personal names (sole or joint): owning the property directly in your client’s name alone or as joint tenants with rights of survivorship is the simplest form of ownership.
- Canadian trust: owning the property within a trust may allow for additional estate planning benefits, but is costlier than the first option.
There may be additional legal ownership options available in the country where the real estate is purchased that provide tax and/or estate benefits. Such structures should be reviewed with extreme caution as the benefits may not be the same for Canadian tax purposes. This can lead to costly consequences such as double taxation with no eligibility for the foreign tax credit.
Foreign jurisdictions may have probate, estate or inheritance tax regimes that differ from Canada’s (foreign real estate isn’t subject to Canadian provincial probate). To address these items, ensure clients consider the following:
- Power of attorney. Having a valid power of attorney in the jurisdiction where the property is located could be valuable when the owners do not have the mental capacity to make decisions. It may also be useful when decisions related to the property must be made when the owners cannot provide signatures in person.
- A will drafted where the property is located may be necessary to address the transition of the property to intended beneficiaries. With a will that is valid in the appropriate foreign jurisdiction, the executor would have the authority to manage the property, including its sale, and to take care of the necessary tax reporting and payments when the owners die.
After taking care of all the tax and estate implications associated with your client’s dream vacation home, they’ll be able to enjoy that beachside villa or Paris flat to the fullest. Or once they know the work involved, they’ll decide to rent and let the owner deal with the tax and estate headaches.