The following is general advice and guidelines for Canadian real estate investors. For more specific advice please review your situation with an experienced advisor specializing in cross-border tax implications.
A common question comes up in our discussions with real estate investors. Many Canadians are intrigued by US real estate investment opportunities but are unsure whether they are a fit for their portfolio or how to get started.
In general, Canadian investors have an overweight in their investment portfolios to Canadian investments whether that is real estate, the stock market, or other securities. Most financial advisors will recommend a diversified portfolio and a design that aligns with your personal financial objectives including your tolerance and appetite for risk.
For purposes of this piece we will assume the situation of a Canadian looking to make a US real estate investment on a “passive” basis such as through a private real estate investment deal or a similar structure as opposed to the “active” situation where a Canadian directly owns US real estate.
As far as evaluating passive US real estate investment opportunities the major considerations for Canadians include the following:
- US Real Estate Market Characteristics – The US market is over 10x the size of Canada, has far more transaction activity, far more liquidity, major differences in real estate fundamentals, and large differences in regulations from state to state. Generally the southern states commonly called the “sunbelt states” such as Texas, Georgia, Florida, and others provide a very pro-investment market while states such as New York and California are subject to higher regulation. The volume of real estate transaction activity is driven by many factors and in particularly the Section 1031 Exchanges causes significant resetting of prices and offers more rapid opportunities for asset turnover. By way of background, a Section 1031 Exchange is a US tax rule that allows US investors to roll a realized capital gain from one property to their next acquisition based on certain criteria. The 1031 offers an enormous tax advantage that US investors have which Canadians do not have access to.
- Sponsor Quality – Canadians generally will know less about the US market or asset class they are investing in which makes it even more critical to evaluate the deal and sponsor quality. A major consideration beyond fees would be to understand if the US sponsor accepts Canadian investors or has an investment structure that can bring Canadian investors in.
- Foreign Exchange Risk – Investing in US real estate would require US denominated currency to make the investment and potentially future capital calls in the future which would also need to be paid in USD. Most Canadians derive their income from Canadian dollars which would cause a foreign currency impacts depending upon where the Canadian dollar goes.
- Financing – Canadian lenders in most cases do not have lending arrangements for US assets. There are options such as leveraging equity from other assets to fund your investment but it does increase the risk on other assets in your portfolio in employing this strategy. US lenders in some cases will lend to Canadians but as expected this will involve more complexity and likely higher interest rates.
- Tax Structuring – In general, Canadians are taxed on their worldwide income including foreign holdings. There are a number of complexities in US taxes including foreign buyer rules and other considerations. The type of structure you choose to hold the investment could even lead you as a Canadian to need to file a US tax return. There are additional implications including withholding tax implications as well as foreign tax credits to consider to avoid double taxation in Canada. In general, tax advice should be sought after with firms that specialize in cross-border tax implications. Leveraging our extensive network of partners our team at Finalyze would be pleased to support you through this process.
Overall, there are substantial benefits and upside in investing in US real estate since it is a major global market. However, there are complexities that Canadians need to consider before placing their funds in the US in particular the tax implications and structuring considerations.
At Finalyze Real Estate CFO Services we would be pleased to explore these situations with you and engage our extensive network of specialists to ensure you are well-advised before making this critical decision. Reach out today at Info@FinalyzeCFO.com or www.FinalyzeCFO.com to learn more!