Holding Canadian vacation property in a Delaware corporation was once a popular means of avoiding the 20 percent land-transfer tax levied on non-residents buying vacation property.

This approach was replaced by normal rates of land-transfer tax in the 1990s and is no longer valid. The use of Delaware corporations to hold Canadian cottage property, however, has become more popular as an estate-planning tool.

The advantages to those shareholders of a U.S. corporation who in turn are residents of the U.S. under provisions of the Canada-U.S. Tax Convention are that the Canadian government cannot tax shares of a U.S. non-resident corporation that are gifted, sold or transferred as a result of death. The increased value of real estate in such a company is only subject to capital-gains tax if the corporation sells the property.

Family-owned real estate could theoretically sit in the Delaware corporation for many years as long as the company does not sell the property. Any gifting, sale or transfer resulting from a death (a deemed sale) would normally trigger capital-gains tax for a non-resident individual owning Canadian real estate personally. The advantages are obvious considering that a cottage could be owned by several family members of different generations, deferring income taxes well into the future.

That's the good news; of course there is always bad news with most situations that seem too good to be true.

Some down sides to Delaware corporations:

1. The rate of tax payable on capital gains by an individual is roughly the same on both sides of the border. The Canadian rate is roughly a maximum of 21.5 percent to a non-resident individual and 14.5 percent to a foreign corporation, for taxable capital gains.

The personal U.S. rate on long-term capital gains is, I believe, 15 percent plus a deductible state tax. It is my understanding that corporations in the U.S. do not receive the beneficial treatment enjoyed by individuals. It is quite possible that the combined federal and state tax rate payable by a company could be in the 35-40 percent range or even higher.

Finally, if the income of the U.S. company cannot be taxed at a personal level, a much greater tax cost will be imposed on the parties.

2. The adjusted cost base of the property to the company will continue to be the historical cost, and future capital gains will be measured from this point.

If the shares of the company were sold to an arm's-length purchaser, they would not receive an increase in the cost base of the property, and the purchaser would be responsible for the inherent tax cost at some point when the company sells the property. This is always a negative when selling shares of a corporation.

3. If an individual owns Canadian real property directly and his or her estate is subject to U.S. estate tax on death, the Canadian tax payable on death can be credited against the estate tax. Accordingly, the Canadian tax will not represent an additional cost (at least the portion that is creditable). This may not be an issue with the apparent phasing out of U.S. estate tax by 2010.

4. The cost of incorporating and maintaining an extraprovincial license and the filing of annual Canadian corporate tax returns is another disadvantage.

5. A Canadian cottage property is sometimes transferred to a U.S. corporation for no consideration (usually by way of contribution by the shareholder).

The Canada Revenue Agency has publicly stated its view that under such circumstances, the property would be considered to have been acquired by the corporation at no cost for the purpose of measuring future capital gains - despite the fact that the shareholder would be considered to have disposed of the property for full fair-market-value proceeds and would be obligated to pay Canadian tax accordingly.

As a precaution, we have recommended transferring the property for full fair-market-value proceeds and paying the consequent land-transfer tax.

6. Another position of the Revenue Agency is that it would consider rent-free use of the property a taxable benefit to the shareholders.

If the agency were to assess along these lines, the result would be the imposition of an annual tax of 25 percent (likely reduced to 15 percent under the treaty) of the fair-market-value rent for the use of the cottage.

We have never seen the Canada Revenue Agency apply either of the above positions in practice, but recommend that readers obtain competent Canadian tax advice prior to proceeding with the use of U.S. corporate ownership.

Despite the disadvantages, the use of a Delaware corporation continues to be a popular estate-planning tool, especially for a higher-priced property with a broad ownership base.

Ken Lenchyshyn, a certified general accountant and certified fraud examiner, is a manager at the Fort Erie, Ont., office of Crawford Smith and Swallow Chartered Accountants LLP. He can be reached at ken@crawfordss.com.