By Don R. Campbell
If you missed out on the earlier posts in this detailed series, here they are for your review. I suggest not skipping any:
Intro – Rule #1 – Rule #2 – Rule #3 – Rule #4 – Bonus Rule
“Hey, the rent is $1,000 how come you only sent me $625?”
The above statement is the well know cry of the “Uninformed Investor.” You can here them in the wild as they try to cover up their lack of diligence with loud calls for change.
Of course I am being a bit sarcastic with that statement, however, you’d be surprised at how many times that investors are ‘surprised’ by withholding taxes or with ‘resort fees’ or any of the other painful economic realities that are foisted on them by both local governments and property managers in these beautiful tropical countries.
“Tax What Don’t Move or Vote”
Inevitably, tax issues follow you wherever you go. An important component of any successful investment is in the tax planning. We all seem to understand that it is not how much you make that matters, it is how much you keep (just look at the deductions on your last paycheque), yet not many people consider the importance of understanding the tax implications of their investments.
An interesting and curious observation: you can make $50,000 on an investment and depending on where it is located, the nature of the investment, and how you structured yourself throughout ownership and at sale, you may end up keeping $40,000+ or less than $25,000… That is why knowing the tax rules before you get in is so important to your bottom line.
The rules vary from country to country/region to region/state-to-state. Each rule will affect your deal and may even inadvertently affect your investments and taxes due in Canada. Some investors have even been caught with double taxation (due to buying in a country that lacks of a tax treaty with Canada or they bought it using the wrong structure). Others have been caught with utilities that are almost double what the ‘locals’ pay for the same service (although the proforma the seller gave them showed the ‘local’ rates). The key is to keep as much as you legally can of what you make – and only by asking lots of questions can this happen.
Sure, in many cases you can apply to get the tax back (or get a ‘taxes paid credit’) from one of the regions (either Canada or where you owned the property), but please note the key words are “Apply to.” That means a process, which means opening yourself up to greater tax scrutiny and in turn means waiting time, and in today’s tougher international tax avoidance rules a very good chance of having your application turned down.
Imagine this scenario, if you hadn’t planned for it in advance: You sell your property a few years from now for a tidy profit. You have a Canadian loan you have been using to buy it. The profits are sent back to you and the cheque is substantially lower than you expected. This is where you learn the painful term “Withholding Tax.” Now you don’t have enough to pay the loan off, nor do you have the rental income to pay the monthly payments.
You apply, at year end tax time, to get most or all of the tax back. But that may be many months away, or may be denied/delayed.
Plan For Reality – Don’t Hide In Perception
Before you sign an offer to purchase, make sure you have investigated the tax implications. Ask questions such as:
· Is there a tax treaty between Canada and the country?
· How will profits (income and capital gains) be taxed in both places?
· What effect does the time you spend in each country have?
· Do you get all of your money, or is there an ongoing holdback?
In some regions, this holdback also pertains to rental income. In other words, when income is being transferred to a foreigner, it is the obligation of the management company / developer to send a portion of that profit to the government who will hold it until all proper tax filings are done at the end of the year. This can take a big bite out of your expected cash flow (plan for it by asking the question).
Property taxes are also an issue that is often overlooked. Find out if you are going to be paying substantially more property taxes because you are from out of the country. In many cases, the local’s property taxes are substantially less than that paid by foreigners, as are the utility rates. Ensure that you are analyzing the cash flow based on the foreigner taxes, not the local. Clearly ask the seller/promoter, in writing, whether the numbers they are presenting you are “locals” numbers or foreign buyer numbers.
Property Management Cash Flow & Performance
In addition to the tax issues, if you are renting out the property for all or part of the year, you must know how the property management company will conduct the finances and how money will be transferred to you.
· Will it be sent by wire, cheque, or do you have to open a foreign bank account?
· Can this cash flow be expected monthly, quarterly, annually?
· How much do they hold back for future expenses/their fees?
· Do they pay the property taxes on your behalf?
· What rights do you have, as a foreigner, to get your money out if the property or the management company doesn’t perform?
· What occurs when there is a deficit in the cash flow?
· How will you be transferring the funds to the management company if required?
When buying any property at a distance you are in essence putting all of your cash in the hands of a second party. What is your trust level with them? What experience do they have with foreign investors? Do you believe that they will be treating your money as if it was their own?
Next up: Rule #6 – Although the last rule in this series, it quite rightly could have been #1