Two Misconceptions of Buying Real Estate in the US.
Note: This is an article written by Dale Walters
There are a number of questions being asked of me, time after time, which tells me there is a lot of misinformation out there. Here are two of misconceptions I hear the most often.
- If I report the rental (or capital gain) income on my Canadian return, I will not have to report the income on a US return. Conversely, if I report the income in the US, I will not have to report in Canada.
- The US estate tax will impose a tax of 50% on all of my US assets.
Like myths and legends, misconceptions typically have some component of fact to them. I will discuss each of the three items and explain why each of them are wrong or misleading.
The first item appears logical because if the income was reported in both countries it would appear the there would be double tax. At the basic level of taxation theory, the country where the income is being earned should have a right to tax that income.
In this case the income is being eared in the US, therefore the US has the right to tax it. On the other side of the argument is that countries in which you are a resident and/or citizen have the right to tax you. In this case, the investor is a resident of Canada and therefore Canada has the right to tax the income. You are saying, but wait, if both the US and Canada tax the income it will be double taxed and owning real estate in the US won’t be such a good investment.
If that were the end of the story, you would be correct; however countries have made a provision into their tax laws to deal with situations like this. It is called a foreign tax credit. To start with, a credit is a dollar for dollar subtraction of your tax liability, as opposed to a deduction which simply reduces the income subject to tax.
For example if we compare a $100 credit to having a $100 deduction, we will have someone in a 45% marginal tax bracket with a $45 tax savings verses $100 tax savings using the credit. At its simplest level, a foreign tax credit will allow a credit equal to the amount of foreign tax paid. If you earned $1,000 of net rental income in the US and owed $150 of US tax, you could subtract that $150 from your Canadian tax.
If we assumed your Canadian tax on the $1,000 was $170, you would subtract the $150 from the $170, leaving you $20 of Canadian tax. Notice that the $150 US tax and the $20 Canadian tax equals the $170 of tax you would have paid anyway, it is simply allocated between the two countries. 
The idea that the US will impose a tax of 50% on your US assets, or worse yet, all of your assets, is based on the fact that prior to 2010, the top marginal estate tax rate was 45%. It is true that prior to 2010, some estates had a portion of their estate subject to a 45% tax. Even then, it did not mean that 45% of a person’s estate was lost to taxes. There were, and continue to be, a base amount of assets that were exempt from tax as well as some of the assets being taxes a lower marginal tax rates.
The US-Canada Tax Convention (Treaty) has provisions for dealing with Canadians potentially subject to US estate taxes. The Treaty allows Canadians a percentage of exemption Americans are allowed, roughly based on the percentage of the assets owned in the US to their total assets. For years 2011 and 2012, the exemption amount is $5,000,000 per person. So if you have assets in the US worth $200,000 and your total assets are $1,500,000, you would have 13.33% of your assets in the US and an exemption of $666,500.
Since the exemption ($666,500) is larger than the US assets ($200,000), there would be no US estate tax. Please note that just because there will be no tax, does not mean that you will not have to file a US estate tax return. You must file a US estate tax return to claim the Treaty benefits and to prove the denominator.
These are only two of many misconceptions. Read my book Buying Real Estate in the US: The Concise Guide for Canadians
