TD Waterhouse Private Investment Advice - Wealth & Wisdom - Fall 2009

Is now the right time to invest in U.S. property?

Many Canadians periodically give thought to buying southern U.S. real estate for use in the winter months.  With U.S. home prices having fallen in recent years and the Canadian dollar relatively high versus the greenback, more Canadians may now be examining this option.

Recent history
U.S. housing prices doubled from 2000 through mid-2006.  Why?  In the wake of the economic downturn early this decade, U.S. interest rates were kept very low for an extended period and credit for prospective home buyers was easy - in some cases too easy - to come by.  The result was very strong demand for housing, which caused a spike in prices.
This led to a boom in the home construction, just as the ability of the typical American to buy a house was deteriorating as a result of rising prices.  That decline in affordability, coupled with the credit crisis, caused prices to fall markedly from mid-2006 to the present.

U.S. housing today
The good news for prospective buyers is that prices today are well below their 2006 peak, with U.S. homes at their most affordable level in many years.  At the same time, the rate of decline in house prices is slowing and we expect prices to bottom later this year or early next year.
In addition, our loonie is much stronger than was the case only a few years ago, making purchases less expensive in Canadian dollars.  Finally, recreational real estate is a discretionary purchase, which makes it very volatile in price, with the result that Florida and Arizona markets - favourite spots for Canadians - have seen their prices fall more dramatically than the national average.
However, potential buyers of U.S. property should maintain perspective.  Home prices have only retreated to 2003 levels, eliminating only the most egregious excesses from the market.  Second, the supply overhang should persist for some time as should tighter credit, so we will not likely see a very bouyant U.S. real estate market in the near term.  In addition, there are important tax implications arising from owning property.

Tax implications
There are three main types of U.S. tax that may be of concern for Canadians who own U.S. real estate: income tax, capital gains tax and estate or gift tax.
 TAX ON RENTAL PROPERTY.  If the U.S. property is rented to a third party, the rental income may be subject to U.S. income tax.  Rental income is generally taxed in a one of two ways: A 30% withholding tax may apply on the gross rent received or, alternatively, a U.S. income tax return may be filed to have the rental income taxed on a net rental income basis.
 CAPITAL GAINS TAX.  The gains arising from the sale of a U.S. property may also be subject to U.S. tax.  A flat rate of 15% may apply if the property was held for longer than 12 months.  If the property was held for less than 12 months, then the gains will be taxed at the regular U.S. graduated tax rates.
 ESTATE TAXES.  Canadians who pass away while owning U.S. real estate may be subject to U.S. estate tax.  Canadians who gift their U.S. real estate prior to death may also be subject to U.S. gift tax in lieu of the estate tax.  The gift tax is based on the market value of the real estate at the time of the gift and is levied at graduated rates similar to the estate tax.
 CANADIAN TAXES.  Canadian taxes may also apply on the income from the U.S. property.  To prevent the income from being taxed twice (both in U.S. and Canada), a tax credit may be available in Canada with respect to related U.S. tax paid.
The tax implications for Canadians who own U.S. real estate are extremely complex.  Consultation with a tax advisor who is familiar with tax laws both in Canada and the U.S. jurisdiction in which the real estate is located is strongly recommended.