You always see me stress the importance of working with specialists in anything related to your cross-border real estate investment. This is because there are myriad minor and major issues that can arise and cost you time, money and aggravation that a “normal” professional won’t know about. Here is a short list of just a few of the common pieces of “advice” that you may get from a US Realtor that isn’t versed in the ownership and management of US real estate by Canadian landlords.
Buy the home in a Limited Liability Company (LLC) to reduce your liability.
While this is fine advice for a US based landlord, this can be disastrous for a Canadian landlord. The issue arises when the CRA looks at your U.S. LLC and doesn’t recognize it as a pass-through entity for tax purposes. The CRA will typically look at your LLC as a corporation and tax the profits on the corporate level, and again when money is distributed. On top of that, the CRA won’t recognize any US paid taxes on your personal return (Because you will be showing $0 taxes paid by the LLC in the US), making you unable to claim the tax credit for foreign taxes paid. Resulting in double taxation!
There are several other, better ways to set up holding your rental home, avoiding liability and avoiding double taxation.
Use a 1031 exchange when selling your home to buy more and delay capital gains tax.
Yes, you as a Canadian are able to take advantage of the tax deferment strategy known as a 1031 exchange here in the U.S. However, this deferment on tax is only going to be recognized in the US on US taxes. You must still report the sale in Canada and Canada does not have a similar 1031 tax deferment provision. This means Canada is still going to tax you on your capital gain, however because you didn’t pay taxes on the capital gain in the US (because they got deferred with your 1031 exchange) you are not going to be able to use the foreign tax credit to offset that Canadian capital gain tax; you don’t avoid any taxes at all then and incur the extra cost of setting up the 1031 exchange in the US.
To make it even worse, when you eventually do sell your real estate without using a 1031, all that deferred US capital gain tax is going to come due. Additionally, because those taxes were due on the capital gain you made sometimes years ago, you may not be able to deduct those taxes on your CRA returns at all, meaning you get to pay capital gains taxes TWICE. Check with your cross-border tax professional, but simply put, DON’T try and do a 1031 exchange if you are a Canadian with US. Real Estate!
Don’t worry about filing taxes if you broke even or only made a few dollars.
This is just bad advice in general that no one should give anyone! One of the first things you should do when you make any income in the US is apply for a tax ID number with the IRS (www.irs.gov/forms-pubs/about-form-w-7). There are many benefits to having an ITIN like electing rental income to be considered “effectively connected income”. By doing so you avoid having 30% of your income withheld but also because you are going to need one to file US taxes every year.
With all the deductions available to real estate investors in the US, like deducting depreciation and mortgage interest, on paper you may not show that you made any taxable profit the entire time you own your US rental home. That’s right, a lot of years you won’t have to pay a loonie in US taxes, however that doesn’t mean that you don’t have to file US taxes every year. The IRS doesn’t look kindly to lack of filing and will fine you for each year not filed in addition to causing you a lot of grief by assuming a worst case scenario of what you could have owed the US in taxes. This will open up a whole can of problems that can be fixable in most cases but will cost you lots of time and money to straighten out. In short, FILE YOUR TAXES.
Put your property in a Trust to avoid estate problems or liability.
This can be good advice, at least half good advice depending on many factors. For one, holding a property in a trust is not going to limit your liability. Some trusts can hide who owns the property on public record, but if you get in trouble or trouble happens at the property, your trust can be required by a court to show you are the beneficiary/owner of the property.
Second, there are MANY different kinds of trusts. What trust will be the best for your purposes, only a cross-border trust specialist can properly advise you about. From estate planning, tax planning, liability planning etc, you need to consult a cross-border specialists.
Renting your vacation or holiday home when you are not using it will cover your expenses.
Sure, this can be true in good years. Florida, and Orlando particularly is a worldwide magnet for tourists that love to stay in homes vs. hotels. Especially if you don’t have a mortgage to pay on a home, you generally should be able to cover your other costs like property taxes, utilities, insurance, association dues, management and maintenance in good and even in moderately slow years.
Management of short-term rentals however, is not cheap. If bookings drop (from general economic conditions or newer and better competitive properties taking your business), you may end up coming out of pocket several months out of the year. If you have a mortgage to pay, even in good years, you should expect to be coming out of pocket for your holiday home in all but the most amazing of months. Also be very aware of the association dues in many of the resort communities. These can range from just a few hundred a month, to over a thousand a month in communities with extensive and high-end amenities. These fees are not going to drop when vacation rents slow, in fact they are more likely to rise over time.
You still have potential appreciation that could eventually pay you back. In central Florida however, short-term rentals are restricted to areas zoned to allow it. And these areas are typically not very attractive to owner-occupant buyers. This makes the market cycle for vacation home values go up and down much more dramatically and much more often than your typical home that is located close to jobs, good schools, and with lower association dues.
This is why BlueHome focuses on long-term yearly rentals as investments. We don’t believe a vacation home should be considered a true investment. It is best to consider a vacation home primarily for the value you get out of your own use of the home and be sure to plan to cover the expenses in slow months.
You don’t’ need Liability/Property/Homeowners insurance.
You may think or have even been told that homeowners’ insurance is expensive in Florida. Many Canadians don’t have a mortgage so no one is going to require you get insurance either (well a good property manager will). So the temptation to simply forego insurance, save the premium and “self-insure”, can be high. There are other ways to limit your personal liability by owning the home in the right kind of corporate entity, however there are costs with setting up and maintaining the right entity and you still run the risk of losing the property itself. Plus, if you don’t maintain your corporation 100% correctly, the “corporate veil” can be pierced! Opening you up to all the liability you were hoping to avoid.
For all these reasons, it’s always a good idea to have your first line of defense be insurance. Great landlord liability coverage can be had for as little $500-1000 per year here in central Florida. Away from the coasts getting coverage for the structure of the home won’t cost much more either. Especially if the home you have has been built within the past 5-10 years. Call a good insurance agent or get a recommendation from your realtor or property manager. You may be surprised how much protection you can get for how little. Find out more about insurance here “Choosing the Right Insurance for your Florida Rental Home.”(Coming Soon)
Let your sales agent manage it for you “on the side”.
Like lots of advice, this isn’t always bad, but think twice about taking it. At first glance, it makes sense to have the person that sold you an investment home also manage it. That means they are all the more motivated to get you the right deal since they will be sticking around to manage it. This first glance unfortunately, rarely holds up when examined more closely. A typical real estate agent is good at what they do and what they do is sell homes.
The skills for “selling” are not the same kind of skills needed to manage. Even with the best of intentions a person good at sales is not likely to also have the attention to detail, skills or personality to do the mundane day to day administration needed to manage effectively. A sales agent also makes 10 times money selling property vs. managing, so automatically managing your home is not going to be high on their priority list.
Worse than being inattentive to your investment, keeping up to date with ever changing landlord-tenant laws and regulations requires a specialist. Along with having enough current experience to know what to do in any of the millions of unique situations that come up when managing a rental. Is your manager going to ask you what you want to do, or advise you on what the best course of action is?
This is why you are best served by either a property management specialist or an agency that has separate people and departments that focus on sales or management.
A good read: “5 Types of Property Managers and What Fits You?”
In summary, you want to avoid the agent that manages your 6 figure or higher investment as a “favor” or “on the side”. Choose a dedicated specialist.
Sell your home while its still rented.
You can certainly do this! It is your property after all, however don’t expect to be able to sell for top dollar. You should expect to have to take at least a 5% to 10%+ deduction on the sale price when selling with a tenant still occupying your home.
Why? Because the best buyer for your long-term rental property is going to be someone that is looking to buy the home to live in themselves. In Florida, the lease you have with a tenant does not disappear when the home sells, it conveys with the sale to the new buyer. And a buyer looking to live in the home themselves is not going to want to wait months to be able to move-in, not going to want to take the risk of the home needing lots of repairs after a tenant moves out, not going to want to take the risk the tenant refuses to move out, and very few have any desire to figure out how to be a landlord.
With enough planning you can add into a lease that you can end it early if you decide to sell the home. However, tenants are going to want a reduced rent because of that uncertainty (no one wants to be forced to move). But even then, you still have another problem when selling an occupied rental. Even the best of renters isn’t going to act like you would when selling your own home.
If you are lucky your tenant will keep the home relatively clean while you are on the market (they do live in the home still, so don’t expect them to keep it show-room clean 24/7 for potential buyers) and there is still the issue of showing availability. As a landlord you have the right to access the home with reasonable (typically 24 hour) notice to a tenant. Without a tenant’s cooperation and consent for each showing however, it can be very inconvenient and very uncomfortable for anyone looking at your property. There are no laws against a tenant following around buyers wearing just their underwear and there are many stories of agents showing a home only to unexpectedly find the occupants in the shower, on the toilet, or together under the sheets….or other places…..eek! Getting the tenants acceptance of each showing essential and is another road block to selling your property.
Even if all goes well, a tenant doesn’t share the same motivation to be all that flexible allowing strangers into their home (it is your property but their home). The limited access is going to keep potential buyers from being able to see it temporarily or permanently depending on if they are only in town a short time or simply find the home they like before they are able to see yours.
This all translates to being on the market longer, which makes your home look “stale” and necessitates price drop after price drop. Usually until the price either gets so low another investor wants to purchase it or the tenant moves out and you are already priced lower than you could have gotten otherwise.
In short, it certainly is possible to sell a home while it is still rented, we do this all the time, but it is going to require no small amount of luck and the extra hard work of your real estate agent.
Sell your home with seller financing.
“Seller Financing” is a not so common, but regularly used real estate investment technique to both defer capital gains taxes, still make a return on your money and usually boost your sales price as well. The simplest way to describe it is that you agree to sell your home to a buyer for an agreed upon price, but instead of that buyer going to a bank to get a loan and paying you everything at closing, you offer to be their bank and collect the sales price over time, plus interest.
With regards to US taxes, you only have to pay capital gains on income when it is received. So you can sell your property this year and collect, for example, a $5,000 down payment and only pay capital gains on that $5,000 this year. Lets say each payment pays you $900 in interest and $100 toward principal, at the end of the year you will have only received $1200 to pay capital gains taxes on (and of course tax on interest….though the Canadian/US tax treaty exempts you from having to pay any US tax on interest payments, that isn’t going to help you). This continues for as long a term as you and the buyer agree to, allowing you to continue collecting an income without the worry about maintenance, management, insurance, etc. that come with owning and renting the home.
Eventually the buyer of the home will refinance with a traditional mortgage and pay you the balance left. If you timed it right, you may be in a lower tax bracket and pay a lower capital gains rate too. Sounds like it has some potential right?
Unfortunately, this is an area that doesn’t sync up quite right between the US and Canada. In the US, you can receive these mortgage payments and principal over any amount of time you want and even delay getting repaid even $1 of the principal. The CRA however only allows you to spread this kind of tax deferment strategy over 5 years and typically only in equal installments. Needless to say, you aren’t going to find a buyer that is going to be able to pay back 20% of the sale price each year, and if they are, they aren’t going to find much value in your seller financing anyway. On top of that you would only be able to apply the capital gains tax you paid in the US the year of the sale to your Canadian taxes in that same year. Since you paid little to no capital gains in the US the year of the sale, you would have little to no foreign tax credit and wouldn’t be able to use future US tax payments to offset your Canadian taxes due.
In short, don’t seller finance as a Canadian property owner.
Do however read up about a creative way to get all the benefits of seller financing without being double taxed in our article “Delay Capital Gains and Make More Money as a Canadian Seller (Without using a 1031)” (Coming Soon).