David A. Altro / October 16, 2013
Using a limited liability company (LLC) is a great option for Americans who own U.S. property. Here’s why.
1. Tax savings
In the U.S., tax rates are lower for individuals than corporations. Although it seems better to hold property personally so the investor has a lower tax rate, this strategy will leave him exposed to liability claims. The alternative is to own property through a LLC. The investor can choose which way the LLC will be taxed as follows:
- Disregarded entity: The IRS sees the LLC as a flow-through entity, which means all the income generated in the LLC is attributable to its owner. So, if the owner is the investor, the LLC will be taxed directly in his hands at the lower individual tax rate.
- Corporation: The income would have to be taxed first as income within the corporation and then as dividends before landing in the investor’s pocket. The same income would therefore be taxed twice, whereas it is taxed only once and at a lower tax rate in a disregarded entity.
- Partnership: This could be considered as a flow-through, but does not provide protection against liability claims, which the disregarded entity does.
2. Liability protection
Liability claims can arise from a real estate investment. For instance, if the investor rents out his property, and a tenant gets injured on the premises, then he could sue the investor for damages. If the investor personally owns the property, this means all his assets can be claimed in the lawsuit. Having a LLC will limit the liability exposure to the assets held by the LLC, leaving the owner’s personal property off limits to creditors.
For Canadians, however, a LLC can cause major headaches due to the U.S.’s new foreign reporting requirements. Though Canadians can personally avoid double taxation thanks to the Canada-U.S. Tax Treaty, CRA does not recognize the flow-through nature of a LLC. This results in a mismatch in foreign tax credits.
Instead, CRA sees the LLC as a corporation—a separate taxpayer, which means double taxation that can be as high as 80% between both countries. So owning U.S. property in a LLC is usually not the right strategy for Canadians.
Further, if a Canadian corporation, instead of an individual, owns the LLC, additional problems arise at tax time. Under U.S. tax law, the LLC can be designated a disregarded entity. This means the Canadian corporation is a non-U.S. corporation and it is subject to branch profit tax. Typically this is set at 30%, but the Canada-U.S. Tax Treaty reduces that rate to 5%. On top of this tax, the Canadian corporation will have to pay dividends tax on any amount it distributes to Canadian shareholders. So even when using a Canadian corporation, the LLC is still not the best way for Canadians to invest in U.S. property.
Some good news
Instead of owning property in a LLC, Canadians can set up a U.S. Limited Partnership (USLP) and take title directly.
A USLP is a flow-through structure recognized on both sides of the border, so it lets Canadians benefit from foreign tax credits and avoid double taxation. A USLP is composed of:
- a general partner, which can be an LLC since it will only receive 0.5% of the income generated in the USLP, but will absorb 100% of any potential liability; and
- one or more limited partners, who would receive 99.5% of the income, but provide liability protection.
Most states and provinces allow limited partners to be directors of the corporate general partner without losing liability protection. Further, the only assets exposed to creditor claims are the ones owned by the USLP, leaving the investor’s personal assets out of reach. So the limited partners of the USLP benefit from creditor protection while receiving 99.5% of the income, and being taxed at lower rates.
Another advantage of the USLP: when partnership documents are drafted properly, investors can avoid costly and time-consuming incapacity and probate procedures. As an intangible asset, partnership interests should pass with the partner’s domestic estate in Canada, irrespective of where the partnership owns assets.
And for investors who own assets in the U.S. and have worldwide estate values over $5.25 million, U.S. estate tax exposure should also be considered.
This tax is based on the fair market value of all U.S. assets owned at the time of death. It can climb up to 40%, depending on the value of the U.S. asset and the value of the worldwide estate. Note this is not a capital gains tax—it’s a value tax.
A well-thought-out structure can help avoid several problems. So consult with a cross-border expert to help set up a structure tailored to the investor’s goals.
David A. Altro, B.A., LL.L., J.D., D.D.N., TEP, is a Florida attorney, Canadian legal advisor and the managing partner at Altro Levy. David can be reached at (416) 477-8155 or firstname.lastname@example.org. Antoine Brosseau-Wery, Esq. also contributed to this article.