In response to an earlier post on Vanguard Total World Stock ETF (VT), reader Doug raised an interesting point — While Vanguard funds have rock-bottom fees, owning US-based assets, including securities, may result in an estate tax payable to Uncle Sam. Doug also posted a link to a BDO Dunwoody bulletin on U.S. Estate Tax Issues for Canadians which points out that the estate tax is a double whammy:

Unlike the U.S., Canada does not have an estate tax. But, when Canadian residents die, they are deemed to dispose of all of their capital property at fair market value, unless the property transfers to a spouse or a spousal trust. As a result, in the year of death, if you are a Canadian resident and you own U.S. real property, for Canadian purposes you may have a large “deemed” capital gain with respect to such property, in addition to a possible U.S. estate tax liability. In some cases, the combination of the Canadian tax and U.S. estate tax liability could end up being a substantial percentage of the value of the property.

Unfortunately, even Canadian residents with fairly modest estates might be liable to pay US estate taxes. For instance, a Canadian resident who owned $500,000 worth of Vanguard ETFs and passed away in 2008 would face an estate tax before exemptions of $155,800. US estate taxes also provides a credit of $780,800 but for non-residents, this credit is prorated based on the value of US assets compared to the value of the entire estate. If our Canadian resident left an estate valued at $3 million (per US rules), the exemption is prorated to $130,000 ($780,000 * $500,000 / $3 million) and would owe US estate taxes of $25,800.

PS: The original post incorrectly mentioned that “Canadian residents will have a U.S. estate tax liability only if their worldwide assets are valued in excess of $2 million”. I regret the error.

This article has 5 comments

  1. You explained the difference of IVV and XSP being the currency hedging with t-bill future contracts and also in higher taxable distributions because the investor owns the t-bill futures and not the actual foreign investment. So wouldn’t this also protect an older investor from possible US estate taxes in addition to currency fluctuations since the investment is actually local?

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  3. Canadian Capitalist

    Jordan: I think so. XSP actually holds XSP but adds a currency hedge on top of it but I think it will be considered as Canadian property. I guess the situation of XSP is similar to VEA which owns equities in Europe and Japan but is considered “US property”. Likewise, XSP owns US securities but since it is situated in Canada, it is not “US property”. I could be wrong on this, though.

  4. Excellent post, very handy info to know at what point international diversification may create tax issues.

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