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June 30 2011

Has there been a more opportune time to take the plunge into the U.S. real estate market?

With the Canadian dollar riding high and U.S. house prices remaining depressed in many markets, it might be a great time to buy that vacation, retirement or income property you've considered.

Guy Sauvé, an investment counsellor with MD Private Investment Counsel Inc., advises "patience and a long-term view."

Along with the usual due diligence required when purchasing a property, prospective buyers must take into account potential hidden costs, like higher-than-anticipated condominium fees, maintenance, geographic market volatility and an array of municipal, state and federal taxes.

Of these, the tax implications may be the most daunting.

"It's a broad area," says Angus Stewart, an estate and trust advisor with MD Private Trust. "There are a lot of details to grasp, and the U.S. federal estate tax situation is a bit of a moving target."

The United States first enacted estate taxes to help fund the Civil War in 1862, and various forms of inheritance levies have come and gone since then. In 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act, which reduced estate taxes over nine years, until they were repealed entirely on January 1, 2010. Eleven months later, President Barack Obama reinstated the federal estate tax, but at a relatively high threshold, with a scheduled return to 2002 levels set to kick in on January 1, 2013.

That means that, until 2013, the federal estate tax exemption is $5 million. On an estate of US$3.5 million—which includes a $500,000 U.S. property—your estate would likely owe nothing, based on a two-step tax calculation formula. Should the exemption revert back down to $1 million in 2013, however, there could be a significant estate tax hit on that half-million-dollar U.S. condo.

There are ways to avoid or ameliorate the estate taxes, of course, but they require planning and will create extra hoops for your executor.

If you plan to sell before death, you'll need to factor in depreciation to calculate potential federal tax implications. State taxes may also apply, although state law is a patchwork quilt across the U.S. You may be required to file both federal and state tax returns.

Of course, if you plan to rent your property, you'll need to file Form 1040NR with the Internal Revenue Service, declaring an annual profit or loss.

The variance in state laws also makes searching title an exercise that can be substantially different from buying property in Canada.

Both Sauvé and Stewart recommend seeking expert guidance. "Visit and talk to real estate agents who know the market you're interested in," advises Sauvé.

Even then, the future of the U.S. real estate market is anyone's guess. The housing meltdown has affected even seemingly bulletproof areas like New York City's Upper West Side, where values declined to $917,000 in 2010 from a median of $1.08 million in 2006. In Fort Lauderdale, median values have tumbled to $173,000 from $400,000.

Has the slide hit bottom?

One thing is sure: Foreign real estate is not like a marketable security. Buying it demands a high degree of due diligence and expert guidance. Managing it requires a hands-on approach. Disposing of it can leave you or your inheritors with some tax consequences.

Weigh your options.