Canadians With US Property

LLP versus LLLP - More information

2012-01-26T08:48:00.002-07:00

A reader sent me this link. I found it quite informative. Thanks Rob! http://www.hatcherstubbs.com/documents/BRC-ArticleLLPorLLLP.PDF

Currency Conversion - New Contact

2012-01-15T16:31:00.000-07:00

I met a new contact at the Calgary HomExpo show:

Annelies van der Made
Private Client Manager/Trader
Firma Foreign Exchange
303-10310 Jasper Avenue
Edmonton, Alberta T5J1Y8
(780)423-2217
1(877)423-2217

www.firmafx.com

She/they do "wholesale" currency transactions of at least $10,000 (although they can do less than $10K in the case of ernest money).

From the discussion, it sounds like they may be as convenient as an online service, and potentially have even more agressive (i.e. low) rate spreads between mid-market rates we see published versus what you actually experience in a transaction. Agressive rates are important when you start looking at transferring enough for a purchase price. If you save 1-2% on $100K, for example, that's a $1-2000 saving.

HomExpo and Seminar in Calgary this weekend

2012-01-13T08:36:00.000-07:00

For anyone interested, Jeff and Dave from RealCore and HousingAngels are in Calgary this weekend (Friday Jan 13th - Sunday Jan 15th 2012) for the HomExpo show. They are also offering a more detailed seminar on Monday (January 16th) evening at the Blackfoot Inn. I have been asked to speak at the seminar, and will be sharing experiences to date. If you are interested, you can register through the RealCoreRealty.com or HousingAngels.com websites. I believe there is a "client appreciation event" afterwards and you can get in on that by registering for that as well. There are two separate entries under Seminars.

This is the seminar that first convinced Brenda and I to "go for it". Most of the other seminars we had attended caused interest but didn't have enough meat to answer key questions.

LLP or LLLP?

2012-01-09T16:47:00.000-07:00

A few readers have asked whether an LLP or an LLLP is the better choice for holding and renting property. Limited Liability Partnership versus Limited Liability Limited Partnership. I am no expert on the differentiation.

We chose LLPs. Our reasoning at the time was that we were trying to provide liability protection for the partners (in this case a couple) as a group rather than protection for the "limited liability partner" from actions of the "general partner". We wanted both partners to be involved and agreeing on partnership decisions, rather than one partner managing the activities and the other being a silent investor.

Here is a site that discusses the options: http://www.referenceforbusiness.com/encyclopedia/Oli-Per/Partnerships.html#b

Any experts out there that can comment?

US Tax Software

2012-01-09T09:38:00.001-07:00

In preparation for tax time, I have looked briefly at available tax software. Personally I struggle with spending a lot of money on accounting services to file a tax return, but of course if you are going down that path you will have no need for tax software. For those that plan to file their own taxes, and who have leveraged LLPs to hold properties, here are some thoughts.

Required support for forms: LLPs file a 1065 return, and put the details of rental income and expenses on an attached 8825 form. Depreciation is calculated on an attached 4562 form. The output of the LLP's 1065 return is a K1 slip for each of the partners. The partners then file 1040-NR individual returns and take the K1 slips as input. So...the full job includes 1065, 8825, and 4562 forms for the LLP; and 1040NR forms for the individuals.

To date I have not found any reasonable (e.g. say under $100) software that handles all of those requirements. Only professional tax filer software which is far too expensive.

Looking at it closer, the complexity is not terribly high, but to the extent that it exists it's mostly with the LLP. The individual 1040NRs can easily be done using downloaded manual 1040NR tax return forms. If I then remove the 1040NR form from the software "requirements list", then there are some solutions.

As in previous years I settled on H&R Block Home Business as a software package to do the LLP 1065 returns. I still find the user interface more difficult than it needs to be, and more difficult than say TurboTax for Canadian Individual Tax Returns. But for me it's better than filling out manual forms for the 1065s. It helps calculate and track depreciation for example. It can also be used for a few LLP returns with only one purchase.

If you want to pursue the H&R Block software, there are online coupons that can save some money. I found one for 20% off and paid about $65 USD. Here's another link that I saw last night. http://www.hrblock.com/tax-software/premium-business.html?otpPartnerID=7825&campaignId=af_mcm_7825_0001&AID=10986834&PID=5459327

If you have different/better suggestions, please attach them as comments for other readers. Thanks.

Financing a Property

2012-01-05T11:02:00.001-07:00

Several readers have asked how best to finance a property: mortgage or otherwise. Here are some considerations:

Interest on a mortgage is a legitimate expense against rental income but according to the IRS web site, only if the loan (mortgage) is registered against the property. Therefore, if you need to borrow money to finance the property, and this was the only consideration, you would likely choose to go with a mortgage backed by the property.

However, at least when we were looking, we found that interest rates on US mortgages were considerably higher than what we could achieve on a home equity line of credit in Canada. So, yes, a US mortgage would be deductible against US rental income, but even assuming we were making enough "profit" to have to pay US tax (unlikely in the short term), the after tax rate would still be about the same as what we would pay on a home equity line of credit in Canada.

Further, since sellers greatly prefer cash deals to those contingent on financing we could achieve a lower purchase that way. Maybe a couple of percent. Maybe even 5%.

Plus, a US mortgage may require "origination points": an up front fee to cover administration costs.

Overall, we decided that, at least in our case, any required financing was better done through an existing home equity line of credit in Canada. Of course that means that you are borrowing in Canadian currency and need to convert and transfer the funds.

Transferring the funds will cost about 1.25% if you use a currency trading account such as XE.com, or a little more (1% more?) if you just use a bank.

And of course your opinion about whether the Canadian dollar will appreciate or depreciate against the US dollar is another consideration. Changes in the dollar valuation may have the largest effect. I just don't know how to predict it with any degree of accuracy. Currency traders get it wrong half of the time!

A more recent analysis may yield a different result. If you do want to pursue a US mortgage, a previous post provided by a reader provides contact information for Washington Federal and they do currently offer US mortgages to Canadians. Many lenders do not.

Annual Reports for LLPs

2012-01-03T07:17:00.000-07:00

Happy New Year!You know what that means, right? Right! For those of us holding properties in Arizona LLPs, it's time to file the Annual Reports.

For each LLP, a simple one-page "Annual Report" that is available on the azsos.gov website must be filed between January 1 and April 30 every year. It just reaffirms the name and address of the "Agent for Service of Process" and the address of the "chief executive office" used by the LLP (if any). You send two copies of the form along with a cheque for $3 and a self stamped/addressed envelope to the AZSOS for filing. Pretty simple. Just something that has to be done to keep on the good side of the Secretary of State. Note: late filings attract a $25 penalty.

Interesting side-note: A notice on the azsos.gov web site says that when setting up an LLP, while you still need to publish the the statement of qualification for 3 consecutive publications of a newspaper, you no longer have to file proof of doing so. That's good. One less step when setting up an LLP. By the way, you did publish your SOQ right? If not, it might be a good idea to tidy that up.

Estate Planning & LLPs

2011-11-05T14:00:00.000-06:00

If you have been following this blog, you know that we settled on LLPs to hold our properties. See past posts for the reasoning and discussion of alternatives such as just relying on insurance. Others have a different view. A recent email from a blog reader (thank you) provided this link:http://www.altrolaw.com/

If you read through the material on the site, you will find reference to a book by David A. Altro called "Owning US Property The Canadian Way", and reference to an article he has published in STEP Journal: http://www.stepjournal.org/journal_archive/2011/step_journal_september_2011/southern_comfort.aspx?link=contentMiddle%20contentMiddleWide.

I have read the book as well as the article. I encourage you to read the online article which really sums up what is in the book. The main point is that owning US property personally or in an LLP leaves you open to estate taxes that can be expensive. David goes on to suggest something called a Cross Border Trust (CBT) that can help in that regard. Basically he doesn't recommend an LLP. I tried a few searches on Cross Border Trusts and did not find any independent sources, so I gather that the recommended CBT approach is a combination of other standard constructs given a name...which does not invalidate the approach.

He may have a point, and there could be merit in his CBT approach. I am telling you about it so you can reach your own conclusions. For me, I would have to engage the author directly to determine the costs and relative pros/cons of the CBT approach before reaching any conclusion. I probably will not be doing that because for our personal situation I do not believe (maybe wrongly) that the estate tax issue will be serious if one of us dies before we unwind US investments.

My basic assumption is that more complex mechanisms cost more to set up and maintain. I am much more afraid of confused tax authorities than I am of working through estate taxes. When tax authorities get confused, they can just assess whatever tax they want and it's up to you to convince them otherwise. Please do not let my conclusion (which could change) sway you. I would be very happy to hear about analysis that draws a different conclusion...if it is based on research and facts rather than fear of a general "you may be subject to costly estate tax". Please do let me know if you have investigated CBTs or other strategies and believe they are affordable and handle the estate tax risk better for average investors.

Estate Tax Exemption

2011-11-05T13:31:00.000-06:00

OK, you have forced me into it. I have tried to avoid the topic of estate planning because it is complex and research never quite gets me to the bottom of it. But I do get a lot of mail on the topic, and many are concerned (rightly) about tax implications if a co-owner or owner dies. The reason this is complicated is that it is under constant evolution. Under Bush-era tax law, estate taxes were declining through yearly increases in the estate tax exemption to the year 2010. At the end of 2010, the tax law that provided for the increasing exemption expired, potentially defaulting back to earlier tax law with very high estate taxes. At the last minute (December 2010), the US passed the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the Tax Relief Act)" which essentially extended and increased exemptions to estate taxes for two years (2011 and 2012). We will have to see what happens then.

Anyway, the nominal amount of the exemption for estate taxes (which has now been combined with gift taxes) is $5M. Great! So no estate tax on the first $5M? Well, not so fast. My understanding of it through additional digging is that for Canadians the unified exemption is prorated based on the ratio of US assets to Canadian Assets.

So, if you have $4m of assets in total, and your US assets (say a house) are $128,000, then the exemption would be 128,000 / 4,000,000 x $5,000,000 or $160,000 and your estate may pay up to 35% of the remainder...so $40,000 x 35% on that $128K property.

For a smaller worldwide asset base...say $2m, with $200k of US property, the exemption would be 200,000 / 2,000,000 x $5m = $500k exemption.

Therefore, your actual exemption would be based on your personal estate value and location. For many, there might not be any estate tax. Others might not be so lucky. But I don't believe it is the earth shattering disaster that many articles would have us believe.

Otherwise, there could be "probate" fees, which I would guess varies by state. I don't believe Arizona has probate fees.

I am no expert on this, just a reader like you. So please check out the Tax Relief Act of 2010 and draw your own conclusions. See above for the full name of the act.

S.1746 VISIT-USA Act

2011-11-05T12:57:00.001-06:00

Two US Senators proposed the "Visa Improvements to Stimulate Tourism to the United States of America" (VISIT USA) Act. The text can be found at http://www.govtrack.us/congress/bill.xpd?bill=s112-1746.
The main intent is to encourage increased investment from "non resident aliens".
There are 8 sections to the proposal excluding "section 1" which just introduces the "VISIT USA" short name for the act. At least two sections are aimed at Canadians. Section 5 (Encouraging Canadian Tourism) provides for 3 year visas for Canadians over 50 that allow stays of up to 240 days. And, Section 8 (Increasing Home Ownership by Priority Visitors) provides for 3 year visas that do not have a 240 day limit, but require investment in real estate of at least $500K including a minimum $250K residence.
This is an interesting development, but it remains to be seen how beneficial it will be. Section 8 details in particular requires the individual to pay US Taxes; and requires a minimum $250K residence which is a pretty fancy house in Phoenix right now. Neither visa provides any other benefits such as the ability to work in the US, fast-tracking of a green card, or access to social programs. Then of course, there are the Canadian impacts of being outside the country for more than 180 days. Something to keep an eye on anyway.

Washington Federal Financing Update

2011-11-05T12:23:00.001-06:00

Here are some highlights of the financing available from Washington Federal sent in by a reader who followed up on the previous post. (Thank you.)
- Single family residences only (no multi-family, condos, condo conversions, town homes, manufactured homes)
- Minimum load amount $50,000; Maximum is $500,000
- 30 year fixed rate
- Loan to value 65% or less (i.e. 35% down payment)
- Available for both "second homes" and "investment loans", with some differences in the details.
Call Washington Federal for details. I have no relationship with Washington Federal or further information.

Financing

2011-10-03T16:53:00.000-06:00

Here is a tip from a blog reader. I have no personal experience with this but apparently Washington Federal is able to offer financing for Canadian Investors purchasing US Real Estate. Contact information is:

Jamie Cordova
Branch Manager
Washington Federal
NMLSR #560554

Glendale Branch
6895 W. Bell Rd. Glendale, AZ 85308
Office: 623-334-9724
Fax: 623-334-1689
jamie.cordova@washingtonfederal.com

Thanks Dillon! And thanks Jamie for granting permission to pass on your contact information.

Insurance

2011-08-03T17:35:00.001-06:00

Don't forget about house insurance. Specifically landlord insurance if you are renting it out.

When we purchased the second property, we changed to State Farm because they were able to offer $2M liability and at a slightly lower premium than for $500K at our previous insurance company.

Katie Campbell (623)815-8170
katie.campbell.hg60@statefarm.com.

We have been happy so far. No hassle at all to clone the coverage for the third house.

If you go there, please tell her Gord Stevenson referred you. Last time someone mentioned that I had referred them, she sent us a $10 gift card. Unexpected, but nice. Thank you. :-)

Once we get the house moved to the LLP, and bank account finalized, we will ask State Farm to put the LLP's name on the policy, and take any further payments from the LLP's bank account.

Registering the property under the LLP

2011-08-03T17:28:00.000-06:00

Assuming the offer and closing was done under your own names, how does the property get moved under the LLP?

Well, there is a form. There would be. :-) It's called a "Quit Claim" deed. Samples can probably be found on the Maricopa County Recorder's site.

The Quit Claim Deed needs to be sent to the Maricopa County Recorder's office, along with a fee of $10. Maricopa County Recorder:j 111 S. Third Ave, Phoenix, Az, 85003. (602)506-3535.

This time we will submit the Quit Claim Deed ourselves. In the past we have had someone (Title Company or a local Paralegal) do it for us. I assume we will need to send two notarized copies of the Quit Claim Deed along with a self addressed, self stamped envelope.

Here is a link to a sample Quit Claim deed...the one that we used to transfer our first property from the LLC (after we figured out that approach had some risk) to the LLP. http://recorder.maricopa.gov/recdocdata/GetRecDataDetail.aspx?rec=20091131451&suf=

For this purpose the Quit Claim deed would be from our individual names to the LLP, instead of from an LLC to the LLP.

Update November 5: Two things: (1) The Quit Claim form needs to be notarized. We were going to be in the US in late August anyway, so we took the form with us and had it notarized at a US bank. It was convenient and inexpensive ($6) and avoided the risk of being rejected because of a lack of recognition of a Canadian "Commissioner of Oaths" or a Canadian notary. (2) Sending two notarized copies of the form to the the Recorder was a mistake: They sent it back saying "you sent two forms and included only one fee". Sigh. So I removed one copy of the form and sent it back. They recorded it and sent me back the form. My mistake. I guess they don't need to keep a copy. Anyway, the do-it-yourself Quit Claim approach was successful. It took a couple of weeks to be viewable on the web, but I can see the property is now registered to the LLP.

Bank Account

2011-08-03T17:02:00.000-06:00

As mentioned earlier, we like to maintain separate finances for each LLP. Separate businesses, separate finances.

We continue to have good luck with Midfirst Bank. Personal and business accounts can be had for free. Sure, extra services cost something. Buying cheques; sending/receiving wires; "bill pay" (if you need that). But you can have a basic chequing account with debit cards that double as Visa credit cards...for free.

I have heard that the only good alternative among Canadian banks is Royal Bank. They have a US arm and can set up Canadian and US accounts where you can transfer money back and forth. We have no experience with them.

Midfirst is able to set up bank accounts without a US address. The first time there was a bit of confusion about that, and there was some trouble getting by one of the steps in the process. But ultimately they were successful. I believe they used the Bank branch's own address at one point in the process. That was handy too because when we use the debit card at a US gas station, the bank's Zip code works.

EIN for the LLP?

2011-08-03T16:48:00.002-06:00

OK, here's a difference. The phone number for the special IRS service to set up EIN numbers for foreigners has changed. (267)-941-1099. They basically walk you through the SS-4 application form that can be found on the IRS website, and give you the EIN at the end of the call. Unbelievable. Imagine that happening in Canada.

Another important outcome is the name of the form that you should fill out at tax time for this LLP. It should be a 1065. If it is not, then go back and figure out which answer you gave them that drove a different outcome and try a different answer until you get 1065 as the outcome. This is the correct form for LLPs (and LLCs for that matter) being used for holding/renting property.

The IRS will follow up the call with a letter confirming the EIN and indication that you should fill out a 1065 at tax time. Keep that letter for the LLP files.

Oh yes, why do you want an EIN in the first place? (a) You need it to open a bank account for the LLP; and (b) you need it to annually file the 1065 tax form for the LLP. Somewhere along the way they will ask that question in the phone call...why do you need an EIN? The magic words are "to get a bank account".

LLP Set Up - Logistics

2011-08-03T16:00:00.001-06:00

Anything new on setting up an LLP? Nope.

- Go to the Arizona Secretary of State web site: http://www.azsos.gov/
- Under Business Filings/Partnerships, do a search to check whether your LLP name is already used.
- Under Business Filings/Partnerships/Forms, select "Statement of Qualification for Conversion (LP not already on file with this office)".
- Fill out the form...send two copies, along with a self addressed, self stamped envelope to the AZSOS.
- They file the registration, stamp a copy and mail it back to you.
- You then need to "publish" the Statement of Qualifications in 3 consecutive issues of a publication. We used Record Reporter (a Daily Journal publication) at http://www.recordreporter.com/. Cost about $40. They mail back a confirmation that it was done. Make sure they know it is an LLP and not an LLC.
- File the confirmation with the AZSOS to complete the LLP setup. The Record Reporter says they will file a copy with the AZ government. But they are used to dealing with LLC's which are filed with a different department. We will see how it works out this time. If they do successfully file it with the AZSOS, great. But I will check and file it myself if not.

Tricky bits?
- What goes in what field on the form. You can probably do a search and find one on the AZSOS site as a sample.
- And...you need a "process agent" with a local (Arizona) address. What the... Jeff!!! Did I mention that he was helpful? The alternative is a paid service that some paralegals or lawyers offer.

Currency Conversion - Revisited

2011-08-03T15:41:00.000-06:00

When we bought the first property, we used Custom House...a currency exchange company. That worked well. Later they were acquired by Western Union, but I assume it still works pretty much the same way.

Since then, another option has become available: online currency exchange accounts.

We have set up an account with XE.COM, which I believe is run by Custom House. The account can be set up online, although there are steps (as you can imagine) where you need to scan/send them copies of supporting documents to prove you are who are say you are. It probably took a week or so to get it completed.

You link your Canadian and US bank accounts to the XE account. Then, when you want to transfer funds, you log on to XE, get a quote, and initiate the transaction online. Funds can be taken from your source account by EFT, or by Wire (which turns out to be an alias for "bill pay"); and they can be deposited to the target account by EFT or by Wire (which really does mean wire).

That's what we did for this property. The only hassle was a limit of $10K for EFT transactions...which I believe is actually a source bank limitation. We probably could have gone through steps to change the limit, but we just transferred the cash in $10K increments over a few weeks...which also meant some smoothing of the exchange rate.

Speaking of exchange rate...I don't know what the actual algorithm is, but it felt like we were paying about 1.2 or 1.3% for currency conversion using XE. I believe the banks are 2-2.5%.

If you don't have a US bank account, you could probably wire directly from the XE account directly to the Title company.

Jeff Dicks - Still the right Real Estate Pro?

2011-08-03T15:31:00.000-06:00

We have been working with Jeff since January 2009, and he has continued to be there for us at every turn. He has literally saved us $1000's when we consider purchase price, efficiency in finding renters, dealing with issues at much less cost than we could have, etc.

When systemic issues have come up...such as the cities wanting rental taxes...he put in place an accountant to take care of that for us (and all his clients) instead of us having to file monthly taxes with the cities for each property.

And he's good at finding properties.

So yes, that decision stands. He sold us the third property.

Jeff's main search website is findhomesfromhome.com. I also suggest that if you are interested, ask him to add you to the "Jeff's deal of the week" distribution list.

Jeff@realcorerealty.com

LLP still the way to go?

2011-08-03T14:00:00.000-06:00

Well, we did it again. With the strong Canadian dollar, and depressed housing prices, we bought another property in Phoenix. Another single family residential property that we will be renting out.

This provides an opportunity to revisit learnings from the past and see if some should be updated, so you will see a few new posts as a result.

Let's start with the decision to use an LLP. The previous reasoning for holding the property in an LLP was that (a) an LLP provides extra liability protection in the same way that an LLC does; and (b) an LLP should not be as prone to double taxation as we feared an LLC would be. (b) is because an LLC is taxed as an individual in the US, but Canada does not have an LLC construct so would probably see it as a corporation...and the tax agreement between the two countries does not allow personal tax paid in one country to be credited back against corporate tax due in the other. So, an LLP should be better from that perspective than an LLC, with the only drawback being that an LLP requires at least two "partners" while an LLC can have one "owner".

So...to today. That reasoning still holds. Therefore, if I want/need the additional liability protection, then an LLP seems to be the way to go. The question is...do I want/need the additional liability bad enough to put up with the extra administration work?

When we decided to go with LLPs previously the maximum liability insurance available from the insurance company we were referred to was $500K. Even by Canadian standards that is too low. Strangely, even with the reputation the US has as a very litigious country, $500K seemed to be the standard. Not good enough, so LLP. But later, we found that State Farm would offer $2M, so we switched. OK, is $2M enough? Probably for most circumstances. The LLP still offers the additional protection of isolating your other assets from any liabilities relating to this property. It becomes a game of probabilities. What's the probability of incurring a liability from a lawsuit over $500K? Whatever the answer is, the probability is significantly smaller if the number is $2M.

Conclusion: We're already down the path of using LLPs for the other two properties and we have to maintain the additional administration for those anyway. One more is a minor addition. So we will continue with the LLP approach for the third. If it were our first property, it would be a more interesting debate. Not sure which way we would go. For sure, the alternative would be holding the property in our own names, not an LLC.

Annual Reports for LLPs in Arizona

2011-01-02T19:51:00.000-07:00

If you have set up an LLP to hold your rental property, it's that time of year. Fortunately, it's dead simple. Just fill out the form located on the AZSOS web site, and submit in duplicate with the $3 fee and a stamped self-addressed envelope so they can send back a copy with their seal stamped on it. Good thing you kept a couple of US stamps in inventory. If you didn't, I once had success by sending $4 (instead of $3) to pay for the postage.

From the AZSOS web site:

Question: What partnerships are required to file annual reports and when are they due?

Answer: All partnerships containing the word "liability" are required to file an annual report. These reports are for the preceding year and due between January 1st and April 30th. A report for the year 2000 is due between January 1st, 2001 and April 30th, 2001. The filing fee for an Annual Report is $3.00.

Annual Report form: http://www.azsos.gov/business_services/Forms/Partnerships/llp_annual_report_form.pdf

City Rental Tax

2011-01-02T19:09:00.000-07:00

OK, I should have seen this one coming. The city in which a rental property is located wants some tax revenue from rental income. In Avondale it is 2.5% and in Phoenix it is 2%. Landlords are expected to charge renters the tax, and remit it to the city. Monthly.

Even if the renter pays the tax, it is still potentially a paperwork headache for landlords.

Fortunately, the Property Manager we use...National Rental Pros...has stepped up and hired an accountant to look after it. There is an initial $19 fee to register the Property Manager as an agent for this purpose. In the case of NRP, it is transparent to the property owner thereafter. Nice!

FIRPTA - Watch out for this one!

2010-03-21T21:19:00.001-06:00

Foreign Investment Real Property Tax Act

We bought another property: a small rental house. Unlike the last one, this was not a foreclosure where we were buying from Freddie Mac. The sellers for this one were a married couple.

Good deal, good house. All seemed well. The HOA was slow responding but after a few weeks we were ready to close. The title company sent the paperwork.

First page...the numbers. Looks reasonable. Hummmm. No property tax adjustment. I guess they had paid their taxes up. Well, let me just check. Maricopy County makes that information available online. Ah, no...last year's taxes were not paid. Title Company: "Oh, thank you for noticing that: we missed it." !!!! But I digress. That is not the point of this post.

Second form to sign. A disclaimer saying the buyer (us) is acknowledging that the Title Company has no responsibility for FIRPTA. Huh?!?! I actually know what FIRPTA is, and this is an unacceptable risk.

FIRPTA is the IRS's way of not having to chase foreign sellers for Capital Gains taxes. FIRPTA puts the responsibility on the buyer to (a) determine whether the seller is a "foreigner"; and if so (b) the buyer is supposed to withhold 10% of the purchase price and send it to the IRS as a tax installment. The seller would then file their tax return to adjust to the correct amount and claim back any excess.

So how is this supposed to work if the Title Company has no responsibility? We, the buyers, have zero contact with the sellers. The consequence is that if the sellers are "foreigners" and they don't properly submit their tax return, we (the buyers) could be on the hook for whatever the IRS deems as the seller's tax liability. In this particular case, the sellers had not paid their HOA fees in over a year; nor had they paid their property taxes, so there was a significant risk that they also would not file their federal income taxes and/or clear up capital gains. In reality they probably did not make money on the house because they had spent a lot upgrading it. However, there was a significant difference between the current selling price and what they paid for it a few years earlier, so without a proper accounting of upgrade costs the IRS could easily assume there was a capital gain. Risky.

In our case, we had three choices: (1) unwind the whole deal; (2) disengage with the Title Company and engage with a new (and hopefully better) Title Company; or (3) deal with it ourselves. With the help of our excellent Real Estate Pro (yes Jeff...the same one) we solicited proof from the sellers that they were not "foreigners".

According to the IRS, "A person who meets the substantial presence test (183 day rule per IRC Section 7701) or is considered a resident alien for
income tax purposes is no longer considered to be a foreign person."

The sellers were able to produce a copy of a social security card and evidence that they were receiving social security income. So we felt that was solid proof that they were not "foreigners" for tax purposes, and closed the purchase. However, that is a personal judgement and we are still not satisfied that the Title Company has done their job and properly protected us. Still, the risk is pretty small with that evidence.

Be careful out there!

By the way, this all applies to us "foreigners" when we sell too. We should expect, notwithstanding Title Companies like this one, that we could have 10% of our sale price withheld when we sell. This is not a big deal if you are expecting it. There are ways to reduce or eliminate this requirement if there are good reasons why you really won't owe that much tax; or you just get the rest back when you file your next US tax form. So no need to panic on that count.

Success - New ITINs!

2010-03-21T20:50:00.000-06:00

Individual Taxpayer Identification Numbers are used by those of us that do not qualify for US Social Security Numbers, so that we can file taxes in the US. Unfortunately the process to get one more difficult than, for example, getting an EIN for a partnership which can be requested by phone.

To get an ITIN you file a W-7 form. In order to qualify for an ITIN you need to meet one or more of the criteria on the form. And specifically there are a small subset of those criteria (that probably don't apply) for which you can apply in a standalone manner. It appears that most need to apply for a W-7 at the time when you first submit a tax return. Interesting, because the tax return that you are filing at that point wants an ITIN included on the form. Chicken or egg?

Anyway, the way this works is that you fill out the W-7 (with attached documentation), attach it to your 1040NR (or whatever your first return is that requires the ITIN), and you mail the 1040NR to the location that processes W-7s instead of the location that processes the 1040NR (or whatever form). The W-7 processors assign an ITIN, probably write it on the return, then forward the return to the processors for that form.

This all seems odd, because for example in our case we are submitting:
- 1065 (Federal return for the partnership)
- 165 (State return for the partnership)
- 1040NRs (federal - individual)
- 140NRs (state - individual)
All of them are asking for an ITIN, and only the 1040NRs are sent with the W-7 application. For the rest we just input "Appld For" in the space where the ITIN was supposed to go.

There are at least two ways to mess this up if not careful.
1) Do the W-7 incorrectly
2) Follow the submission instructions for the return instead of sending it to the W-7 people.

A quick Google search will provide a long list of horror stories about (1) messing up the W-7 submission. To help with this the IRS has authorized Taxpayer Assistance Centers (TACs) to help you apply correctly. I phoned a local TAC (yes there are some in Canada) who agreed that there is a very high percentage of rejections and therefore it is a very good idea to get help; but then went on to say that it would be $600 to get that assistance.

I don't think so.

More Googling, looking at the criteria, following the bread crumb trails. It appears that the likely place to fail is submitting a copy of your passport that is not properly notarized. The IRS requires that copies be notarized by a US notary. I.e. A Canadian Notary probably won't cut it. It seems that authorities from countries that signed the Hague Convention can do the verification and provide something called an "apostille", but it seems that Canada is not on the list. Probably this is the source of many rejections.

When we first looked at the ITIN story, we determined that we did not qualify for applying at that time and would have to do the application many months later when submitting the first return. So we just photocopied our passports (the main picture page) and had the copies notarized in the US on our next visit there. That seemed to work: our W-7s were accepted and ITINs came in the mail.

US Taxation - Software

2010-03-21T20:11:00.000-06:00

I prepare my own tax returns, and in Canada have generally used tax software on a computer to help out. I searched for appropriate software for the US, and did not find a great answer. Please let me know if you did.

I was looking for a package that would support:
a) US Partnerships (1065)
b) Rental income under a partnership (8825)
c) Non-resident Alien individual returns (1040NR)

No luck.

I did find software that supports (a) and (b), which does help. But then you're on your own to download and complete the 1040NR manually. I chose H&R Block's Business 2009 for (a) and (b), and frankly found it a little disappointing compared with using packages aimed at Canadian taxes. I found the user interface poor, and found myself struggling at times to get what I believed to be the right calculations when rolling up the 8825 information onto the 1065. It could be that I've just had much more experience with Canadian taxes, but if I were doing it again I might try a different package. Better than totally manual though.

Please let me know if you find a better answer.

Rationale behind choosing an Arizona LLP for holding real estate

2010-01-24T11:45:00.000-07:00

Several have asked for more detail on our reasoning behind our choice of an Arizona LLP as the holding entity for the real estate property. Why an LLP? Why not an LLC? Why an Arizona entity? Why not an Alberta entity? Why not just hold the property in our own names?

The only benefit we are seeking with a holding entity is liability protection. Specifically, if any lawsuit exceeds the protection offered by insurance on the house or condo, remaining liability will be limited to that property and not any other assets.

A reasonable debate could be had with respect to the size of the risk without such protection. Many people hold property in their own names and insurance would offer some protection. I really do not know the probability of the LLC/LLP protection being required but I do believe the probability is higher if you rent the property, and also that it is higher for a US property than it is for a Canadian property. Even in Calgary there was a recent incident where the landlord is facing a huge liability exposure.

Regarding taxes: there seems to be consensus that holding the property in your own name or in an entity that is taxed as a person results in the lowest taxes in the US. I understand that both rental income and capital gains are taxed at higher rates if the property is held by a corporation.

For US residents that is the beauty of LLCs. LLCs offer the liability protection of a corporation, but from a tax point of view the income flows directly through the LLC to the 'members' of the LLC and tax is paid personally.

Unfortunately it seems that the CRA in Canada treats LLCs as corporations. The outcome may be paying tax personally in the US and not being able to claim it back against corporate taxes in Canada because they are of different classes. Double taxation. Note that there is something called the Fifth Protocol which is a very recent update to the US-Canada Tax Treaty that makes a change to treatment of LLCs. However, it is one of the most obtusely written pieces of text that I have ever read. It appears to have more to do with US LLC's doing business in Canada, and does not look like it fixes this problem, but future interpretations from the CRA may change that.

Anyway, there is another answer: an Arizona LLP. Limited Liability Partnership. Not a Limited Partnership (LP): an LLP with two Ls. An Arizona LLP appears to have the same liability characteristics as an LLC but should be seen by the CRA as a partnership rather than as a corporation. So, personal income on both sides of the border. In most cases the IRS treats LLCs and LLPs in exactly the same way, and in fact LLCs file the same 1065 return that Partnerships do.

So why set up the LLP in Arizona rather than Alberta? My understanding is that Alberta restricts LLPs to a short list of professional partnerships, such as a Medical Practice so it is not an option for holding real estate.

I have recently heard that "oh yes but Alberta has the LP (one L) which can offer the same protection". My belief is that an Alberta LP is similar to an Arizona LP, and it only offers the liability protection if there is also another entity involved, set up as the general Partner: so it is really the other entity (e.g. Corporation) offering the liability protection. Too complicated and too expensive and difficult to maintain in my opinion.

Also, I firmly believe it will be less confusing if the complexity is contained as much as possible to one tax authority. Using an LLP for this purpose is a pattern well understood by the IRS as is foreign ownership of a parnership. And I believe the CRA will also be clear on dealing with Canadian ownership of a US partnership. Some sort of hybrid may confuse one or both tax authorities resulting in painful discussions and/or a surprise outcome.

For me the Arizona LLP route offers the best balance of liability protection and only minor complexity. And it seems to be the lowest cost approach as well. I was able to set up an LLP in Arizona for under $100. Although there may be enough benefit to utilizing the services of an Arizona notary/filer to make it worthwhile if you need assistance.
Realcore referred me to Adam Nierenberg (AccurateSignings@aol.com or 602-779-1873) for another similar purpose and that was a positive experience.

If you are inclined to do it yourself, please refer to the Arizona Secretary of State (AZSOS) site for instructions. If desired we offer our samples to anyone who donates.

The only loose end in the deliberations is whether any of the more complex structures offer better protection against Estate taxes. The fear that I have heard is that if your world-wide assets are large enough and the US propery is worth enough, the IRS may want to calculate estate taxes on your worldwide estate. I have not fully researched that aspect but there are exemption levels that most people probably fall below. If you have any clear insight into that aspect please let me know.

Just to be clear I am not a legal or tax professional. These are just my understandings from reading and from hearing seminars. Please seek your own professional advice as you see fit.

To depreciate or not to depreciate...

2010-01-12T19:50:00.002-07:00

When renting out a property, the IRS allows the property to be depreciated...ruducing the net income that tax is paid on. Of course, later when the property is sold, capital gains will be calculated based on the depreciated value.

So, what to do? What to do? We are typically conservative, and it is not obvious that the value of the property will decrease. So, should it be depreciated?

Well, we have seen online references, and heard the same from an IRS representative, that it does not matter whether depreciation has been taken (on tax forms) or not! When it comes to Capital Gains, the IRS considers the property has been depreciating, whether or not the depreciation expense has been claimed.

One example of evidence is this language from the description of "decreases to Basis" in IRS publication 523 (Selling your Home): "Depreciation allowed or allowable if you used your home for business or rental purposes".

Taxation - Individual

2010-01-04T10:27:00.001-07:00

The IRS has not yet released the 1040-NR form. I called to inquire, and the IRS rep referred me to a web page that lists when updated forms are anticipated. I had not found the page so it may be worth noting for future reference:

http://www.irs.gov/formspubs/article/0,,id=103641,00.html

The 1040-NR form for 2009 is due to be published January 12, 2010.

Taxation - Partnership Level

2010-01-04T10:03:00.000-07:00

In the US Partnerships do not pay income tax directly, but they do file a Tax Return to provide the IRS with information regarding income and expenses, as well as a determination of how much net income should be attributed to each Partner. The Partners then, as individuals, file 1040-NR returns and pay any tax. The Partnership provides K-1 forms to the Partners for input into completing their 1040-NRs.

The Partnership is also responsible for withholding a portion of net income and forwarding it to the IRS on behalf of Partners.

We have now worked through the first instance of a Partnership-level filing. Here is what we are filing:

- 1065 US Return of Partnership Income (Includes Schedules B,K, B-1)
- 8825 Rental Real Estate Income and Expenses of a Partnership (attach to 1065)
- K-1 for each Partner (attach to 1065, and provide to Partners for use in filling out their personal 1040NR forms)

Statement of choice to have real property taxed as income effectively connected to a trade or business in the United States. This may not be required for a Partnership as the default may be "effectively connected" income, but there appears to be no harm in sending it. See “Nonresident Aliens – Real Property Located in the U.S.” on the IRS website. http://www.irs.gov/businesses/small/international/article/0,,id=96403,00.html

The Partnership’s Federal filing is to:
Department of the Treasury
Internal Revenue Service Center
P.O. Box 409101
Ogden, UT 84409
…on or before April 15th

Separate Filing for 8804/8805
- Form 8804 Annual Return for Partnership Withholding Tax (Section 1446) – one per Partnership – summarizes and acts as transmittal for 8805 forms.
- Form 8805 Foreign Partner’s Information Statement of Section 1446 Withholding Tax (one instance of an 8805 per Partner, with 4 copies: one for files of Partnership; one to submit with 1065; one for partner’s files; one to attach to partner’s 1040NR)
- Note that if there are circumstances that would change how the Partnership should calculate withholding for a given Partner, the Partner documents that on an 8804-C and provides it to the Partnership. E.g. Losses in another Partnership that would offset profit in this one.

8804/5 filing is to:
Internal Revenue Service Center
P.O. Box 409101
Ogden, UT 84409

Phoning the IRS for Assistance

2009-12-30T18:03:00.000-07:00

The IRS Telephone Assistance list is at http://www.irs.gov/help/article/0,,id=96730,00.html

However, we have found that the main 1-800 numbers do not work from Canada. There is a link to an International Services page, but none of the provided numbers are in Canada, and they are not 1-800 numbers

We found that the aptly named MagicJack device which provides a Voice Over IP capability and which is usually set up with a US phone number, works well. In our case, the calls “originate” from Phoenix even when we are calling from Canada. That opens up all the normal IRS numbers to us.

The Canadian link for MagicJack is http://www.themagicjack.ca/

Neighbors

2009-12-29T16:58:00.000-07:00

We found it important to introduce ourselves to the neighbors of the property.

They can then call if they see/hear anything you should know about, or if they have a complaint

Complaints can be dealt with before they become a big issue, and potentially less expensively if handled early

They may be more likely to be tolerant if you have made that effort

Ongoing Care/Feeding of an LLP

2009-12-29T16:56:00.000-07:00

File annual “return” with AZ SOS to keep LLP in good standing. See AZ SOS website for procedure and form

Pay HOA fees – quarterly is our experience

Pay property taxes – semi-annually (March and September) is our experience

File income taxes

Otherwise the management company looks after operations – monthly statements show revenue and expenses.

Taxation

2009-12-29T16:54:00.000-07:00

This is a work in progress. There are both US (IRS) and Canadian (CRA)taxes to file, and the usage of an entity to hold and rent the property is definitely a complication.

At an overview level:
- For a simple entity (LLP or LLC) the entity must file taxes as a "partnersip", which means filing a 1065 return
- Rental income and expenses go on form 8825, which is attached to the 1065
- The Partnership also generates K-1 forms that tell individuals what income they should report on their personal tax forms
- Non-Resident Aliens (e.g. Canadians) file 1040NR returns
- A K-1 provided by the LLP/LLC is attached to the 1040NR

Entities such as an LLP or LLC need an EIN number, which can be readily provided by the IRS. Individuals need an ITIN number, which is harder to get and probably must be applied for in conjunction with filing the first tax return.

There are quite a few more details, such as requirements for withholding taxes for Non-Resident Aliens.

Detail will evolve in the Detailed Notes as it unfolds during tax season.

Management

2009-12-29T16:39:00.002-07:00

Assuming you are going to rent out the property, there are really two choices: Do it all yourself; or align with a Property Management Company. For us, the Property Management Company is a far better way to go. The rest of the discussion assumes that.

A fundamental decision needs to be made: are you renting an unfurnished property, or are you furnishing it and renting it as a “vacation rental”?

Typically for an unfurnished property: income is lower; management costs are lower (10% is typical); and most of the utilities are set up and paid for by the renters. You probably still need to pay taxes, Home Owner Association (HOA) fee, and potentially a pool service. For our property those are about $250/month total ($150, $35, and $65 respectively), but a condo would have higher HOA fees. However, there is less frequent turnover of renters; you have no ability to use the property yourself.

Conversely for “vacation rentals” you pay for furnishing and outfitting the property to make the property useful for a vacation. That means furniture; kitchen appliances, dishes, utensils; linens, etc. Therefore you need to add capital to your acquisition cost. Depending on the property that could be $5K or $20K. And time to manage the build out. Wear and tear on furnishings is your responsibility, and thinking about wear and tear may cause you to make furnishing decisions that are different than you would make for your own long term use in the future.
You pay all utilities. Heat, electricity, cable, internet, phone in addition to those mentioned above for an unfurnished property. Income will be much higher when occupied, but there will be more unoccupied time.
You can book the property for your personal use if not already rented
A typical management fee is 30% of income.

A good choice of Management Companies is very important to (a) the amount of hassle you experience; and (b) the ongoing maintenance costs. We aligned with Jeff Dicks of National Rental Pros, and that has been a very good experience. He was also our Real Estate Pro, so the property seamlessly transferred from acquisition into managed mode, and he directed all the initial repairs and set up activities with very little intervention on our part. He even arranged for acquiring and installing an almost new washer and dryer.

Insurance

2009-12-29T16:34:00.000-07:00

You need Insurance on the property to go into effect on the day of closing. Hopefully your Real Estate pro’s contacts include a good insurance agent.

Preferably, if you are using an LLC or LLP, the insurance should be in the name of the entity and be paid from the entity's bank account.

If you are going to rent the property out, you need a landlord policy

Closing

2009-12-29T15:29:00.000-07:00

Tips that helped us:

Find out the name and contact information of the Escrow Officer handling your file at the Title Company and introduce yourself early. Get phone and email contact information.

Understand that he/she is probably doing over 100 of these in a month, and has little time to focus on yours.

We found it advantageous to talk to him/her early and understand the steps and make sure it keeps progressing, because you are up against a closing deadline that seems to apply to you (under penalty) but the seller and Title Company can miss all their milestones leaving you no time. Some of the key items:

- Disclosure statement from the HOA – they need you to pay for that and no it cannot be just added to the closing costs. And the online pay facility may not like your Canadian “zip code” that you type in to validate your credit card. That may require a phone call to the intermediary collecting the fee; or to the HOA. When we ran into this roadblock, our Real Estate Pro paid the fee and added it to his invoice. Thank you! Remember the need for a good Real Estate Pro?

- Contracts will be faxed back and forth. By the way, the contract (offer) that you already submitted? No good. The selling Bank has their own, which puts more of the fees on you. Offensive, but just understand that the total is going to be 1.5% of closing costs or thereabouts and don’t worry about how you get there. The selling bank is taking a huge write-down on the house value so maybe the slight shift in fees is not such a big deal. Ours was just under $2K on a $115K purchase.

- You were probably advised to write the offer as “cash” with a quick closing date and no conditions to make your offer attractive to the seller. That’s what we did, and it probably helped achieve the lowest purchase price. But you still want to have the property inspected so there are no surprises, and you don’t have much time. This is where the Real Estate Pro comes in. Again. Hopefully he/she has the processes and contacts in place that you will need to get this done on time.

- The offer was probably in your own name(s), but you may have decided to hold the property in an LLC or LLP. If that is the case, we found that explaining the situation to the Escrow Officer and asking her to file one more Warranty Deed to transfer the property into the entity's name was a convenient way to go.

Holding the Property

2009-12-29T15:12:00.000-07:00

Even if you have already decided how to hold the property, unless you were sure you were going to buy a property you probably haven’t set up the mechanism as of the moment the offer is accepted.

Of course, if you are holding the property in your own name there is nothing to set up. However, if you decided to set up an LLC or LLP it needs to be done prior to closing to avoid a second transaction.

In our case we initially used an LLC, but later decided to move to an LLP due to fears of how the Canadian and US Tax treatment lines up (or not). Rumor has it that the CRA (Canada) may see an LLC as a Corporation while the IRS (US) treats an LLC as a transparent entity passes the income to the individuals from a tax perspective. That may result in double taxation. An LLP is said to provide similar liability protection to an LLC (in the US), and may line up better with personal tax treatment in Canada.

OK, whichever you decide...how is it set up? Do it yourself or use a service to have it set up for you? We used a service for the LLC, then later set up the LLP ourselves to save cost and because the service was not the highlight of our experience.

Even when you determine all the steps and set up the entity yourself, having a local (to the target city) contact who can assist with filing and potentially provide Notary services at a low cost is beneficial.

If you are using an LLC or LLP to hold the property, you may want to set up a bank account for that entity to keep "business" and "personal" entirely separate so as to protect against "piercing the veil" and losing liability protection.

The entity will need an EIN (tax number) for use in setting up a bank account, and later for tax purposes.

We ultimately aligned with a Management Company to manage the property for rentals, and set up the account with the Management Company under the LLP’s name, and linked it to the LLP’s bank account.

Pay the Piper

2009-12-29T15:08:00.000-07:00

Turns out that earnest money cheque was just for show and they don’t want that. They want an immediate wire of the equivalent amount sent to the Title Company’s bank account. Good thing you have a plan already set up for that!

In our case that meant calling the currency broker and initiating the currency conversion and wire.

OK, now you have a couple of weeks to get ready for closing while the seller (bank if a foreclosure) and the Title company do their work

Offer

2009-12-29T14:57:00.000-07:00

The Real Estate pro will know all the required offer paper work. But you need to have an Earnest Money cheque with you to attach to the offer, as well as proof of funds.

You probably do not yet have an LLP (or LLC) set up so the offer will be in your own name(s). At closing time, you can ask the Title Company to immediately transfer the property from your own name(s) to the LLP name. In our case, they did that for no extra cost. It required one more “Warranty Deed”, but the title research had already been done, so it was really just one more form to file.

Do the usual offer/counter-offer dance, and eventually your offer is accepted

Great, the dog has now caught the car and wonders what to do with it!

Looking

2009-12-29T13:15:00.000-07:00

Looking: Some key tips that we found useful:

- Find a good local real estate professional. We aligned with Jeff Dicks of RealCore Realty (and National Rental Pros), and he was (and continues to be) excellent! (602)745-1111
- For renting it is handy if he/she is also (or connected to) a property manager
- If he/she has a network of contacts for repairs etc, that will help reduce costs
- Check for Home Owner Association applicability, rules/regs in addition to the usual information sources. E.g. Make sure there are no restrictions against renting if that is what you intend

Our experience was that a good real estate professional who is well connected, and who can seemlessly manage the property for rent after the sale can significantly reduce expense and workload.

Preparation

2009-12-29T12:57:00.000-07:00

Preparation: If you are going to buy, you need to be prepared with (a)Money; and (b) a plan on how you want to hold and administer the property:
- Ability to write a cheque on the spot for “earnest money” to attach to an offer.
- Proof of available funds or equivalent (e.g. pre-approved line of credit that you can access easily). Proof could be a letter from your bank, or potentially a bank statement.
- Ability to access US funds as needed - E.g. Bank or Currency Broker or both?
- Hold the property in your own name(s), or in a company, LLC, or Partnership?