Originally published in November 2013 by Meghan L. Weinstein
Updated in July 2016 by Shlomi Steve Levy and Jonah Spiegelman
The Florida Land Trust (“FLT”) is sometimes recommended as a structure to hold title of their personal use U.S. real property. It is relatively inexpensive to set up, and is an effective way of avoiding probate on the assets inside the trust. It may also avoid incapacity issues if properly set up. For Canadians owning U.S. real property, however, the FLT may not be ideal. This blog explores the issues that can arise for Canadians holding assets in an FLT.
What is a Florida Land Trust?
A Florida Land Trust is a revocable grantor trust that is specifically created to hold Florida real property. It was adapted from the Illinois Land Trust, which has been used for over a hundred years, and whose main purpose is to keep the property owner’s identity hidden. Land trusts are unique from both revocable and irrevocable trusts under common law, as they vest both legal and equitable title to the real property in the hands of the trustee. Additionally, the trustee is given only administrative duties to perform, with any other duties being dictated by the beneficiaries.
The Florida Land Trust keeps ownership interests of Florida real estate or other personal property confidential and private because the Florida Land Trust keeps your name off the public record. Although this may help keep creditors away, the actual language in the document does not prevent creditors from reaching into the trust and grabbing the property in the event that they have been made aware of the identities of the beneficiaries. In addition, since the trust offers no option for future estate planning for beneficiaries, any potential barriers that exist between the property and the creditors evaporate upon the passing of the beneficiaries or once the property has been distributed.
Canadians owning real property in the U.S. may be subject to pay taxes to the Internal Revenue Service (IRS) in three situations: income tax if the property generates revenue, capital gains tax if the property is sold and U.S. estate tax upon death if he/she passes away owning the property personally.
Canadians are taxed on their worldwide income no matter where it’s generated. Therefore, income tax and capital gain tax generated in the U.S. are subject to taxation by both the Canadian Revenue Agency (CRA) and the IRS alike. This is called double taxation. The Canada-U.S. Tax Treaty, however, allows taxpayers to avoid double taxation, as they can claim a credit (“Foreign Tax Credits”) for foreign income or capital gain tax paid in the U.S. toward the Canadian tax owed on the same income.
Taxation of the Florida Land Trust
Tax on Funding the Trust
If a Canadian resident transfers U.S. real estate from her personal name into an FLT, she must consider whether there is any tax on the transfer. In the U.S. a FLT is a Grantor Trust, which means that the trust is disregarded for income tax purposes. The grantor of the trust (i.e. the person that contributed the trust property) is treated as directly owning trust assets. Thus, when an FLT is funded with U.S real estate, there is no tax event under U.S. law because the property did not change hands for tax purposes.
For Canadian tax purposes, however, the FLT is seen as a separate entity from the grantor. Thus, under Canadian law, a disposition will occur when U.S. property is transferred to the FLT. This triggers capital gains taxation on any current fair market value that exceeds the adjusted cost basis of the transferor
Taxation during Grantor’s Life
Because the FLT is disregarded for U.S. income tax purposes, any income or capital gains generated by the property in the trust will be taxed in the hands of the grantor. A Canadian resident who owns U.S. real estate in an FLT would therefore report any income or gains in a personal nonresident return (Form 1040NR) and pay tax personally. If no income is earned on the U.S. real estate, then no filings are required in the U.S.
In Canada, even though the FLT is treated as a separate entity for tax purposes, section 75(2) of the Income Tax Act applies to attribute any trust income or gains back to the grantor. Therefore, if a property is rented out or sold, foreign tax credits should be available to prevent double taxation on the income. Even so, the Trust is required to file a T3 tax return, which adds administrative costs to maintaining the structure.
However, there may be timing problems in respect of tax on capital gains earned in an FLT. Recall that Canadian tax is imposed when appreciated property is transferred into the FLT. This results in a step-up in basis for Canadian tax purposes, without a similar readjustment on the U.S. side. Therefore, when that property is sold by the FLT, all the historical gain would be taxable in the U.S., while only the FLT-era gains would be taxed in Canada. Further, the FLT will be deemed (for Canadian purposes) to dispose of its assets on its 21st anniversary, without a corresponding tax event in the US. Such timing mismatches often deny the availability of foreign tax credits leading to double taxation on capital gains.
Taxation on Grantor’s Death
If a Canadian resident dies owning U.S. real estate, she may be liable for U.S. Estate tax on the value of the U.S. assets. The FLT does not change this potential liability because it is a revocable trust, and therefore taxable in the estate of a nonresident under Internal Revenue Code section 2038. The beneficiaries then take the asset with a stepped-up cost basis for U.S. purposes.
In Canada, the 75(2) attribution rules only apply to income and gains realized during the life of the grantor. For all other purposes, the FLT is treated as a separate taxpayer, and the grantor’s death does not trigger a deemed disposition in trust assets. However, the 21-year deemed disposition rule continues to apply irrespective of the death of the grantor. This can lead to more problems with cross border matching of the cost-basis, as discussed above.
The information contained herein is for informational purposes only, and is not legal advice or a substitute for legal counsel. It is not intended to be attorney advertising or solicitation. If you have a legal question, please consult with a licensed attorney.