Southern Comfort – David A. Altro considers the advantages and disadvantages for Canadians holding Florida rental properties in a limited liability partnership
When a Canadian citizen residing in Canada buys rental property in Florida in an LLP, the structure will provide creditor protection to the individual. For example, if ‘Bob’ and ‘Mary’, his wife, (Canadian citizens residing in Canada) purchase a condo in Florida in an LLP, the LLP is the owner of the rental property and Bob and Mary are the partners in the LLP. Should the tenant of the rental property slip and fall then sue for damages, the LLP is sued as the owner of the property but Bob and Mary are creditor protected personally.
The LLP presents several problems. First, it ends when the first spouse dies, as there must be two parties in a partnership. Now what? Another LLP cannot be created, as you need two partners, and only one is still living.
On the death of the first partner spouse, the estate will be subject to probate in the county in Florida where the real estate is situated. The probate process is time-consuming, freezes the estate and may cost up to 3 per cent of the fair market value of the property (as of the date of the death of the first spouse).
Probate will be required because, under Florida law, LLPs are intangible assets, which must pass through probate on death unless the interest is held in a revocable trust, such as a cross-border trust (CBT). To avoid probate, each spouse needs to have a CBT that ‘owns’ the partnership interest.
Also, the LLP does not protect against US estate-tax exposure, as the limited partnership holds real estate, which is considered a US asset for Canadians and is therefore subject to US estate tax. The current exemption under the Internal Revenue Code (IRC) of USD5 million on the worldwide estate of the deceased, even with the marital credit available on the first spouse to die to double up the exemption amount, may not protect them from US estate-tax exposure on death.
On January 1, 2013, the IRC exemption drops to 1 million USD on worldwide assets.
I suggest that the bigger issues of probate and US estate-tax exposure be addressed first, rather than creditor protection, as clients typically have liability insurance.
For husband-and-wife clients with moderate estates, I recommend the CBT, or, better yet, a CBT each. Legal fees should be the same to create one or two mirror-CBTs. The structure of two CBTs:
- avoids the contribution rule issue of s2040(a) IRC.
- provides for discounting the value on death of up to 33 per cent for the purpose of calculating the estate-tax valuation on first and second spouse to die.
- ensures that, on the death of the surviving spouse, only their half of the property is included in the estate-tax valuation, and
- means that any tax payable on the death of the first spouse is deferred until the death of, or sale of the property by, the surviving spouse (whichever occurs first).
When clients are purchasing, or own, more expensive US properties and have larger estates, I create a cross-border irrevocable trust (CBIT). The CBIT:
- pays no US estate-tax on death of the first and second spouse, irrespective of property value, the clients’ worldwide estate or the exemption amount
- provides creditor protection, and
- avoids probate procedures at court.
The only time I might suggest an LLP is for law firms or accounting firms (unless I’ve added CBTs to own the limited partnership interests). I do use limited liability limited partnerships (LLLPs) for business purposes or for high-net-worth clients who desire several layers of protection against estate-tax exposure or divulgation of assets on death, or creditor protection. Again, there needs to be a second tier of ownership, so the limited partnership interest should be owned by either another limited partnership or a CBIT.
The limited partnership interest could be owned by a Canadian corporation, but then the capital gains tax rate would be over 40 per cent on the accrued gain on sale, whereas in a CBIT it would be 15 per cent of the gain, provided the trust was the owner for at least 12 months.
Where the Canadian investor plans to acquire US multi-tenant rental property where there is or might in the future be a strong net cash flow, several ownership structures are possible to obtain the lowest possible income tax payable to the Internal Revenue Service and the Canada Revenue Agency. However, the capital gains tax rate might be the higher amount, as described above.
No perfect solution
There is no perfect solution to the challenge of structuring ownership for US properties for Canadians. What is most important is showing the client the issues, options and best-case proposals.
© 2011 Society of Trust & Estate Practitioners