Real Estate in Mexico

[Michele]

Our Broker and friend at Realty Executives, Tom Budniak, compiled this information from various sources and distributed it to us a few days ago. I think it is particularly informative (and accurate). There is a lot of misinformation floating about here in Playa del Carmen. Let's try to clear some things up, one at a time.

Today.........


Capital Gains Tax in Mexico…Separating fact from fiction

The information provided here will help you understand the tax system in Mexico and the important issues related to it. Regardless, you absolutely should meet with a tax professional prior to completing your purchase to confirm whether any of the laws have changed since the publishing of the tax document in 2005.

CAPITAL GAINS TAX

Capital gains tax law in Mexico states that tax is owed on the profit you receive when you sell your home or property. By law, you have two options when it comes to capital gains, and you can use whichever is the better of the two options for you.

Option 1: 28 percent of the net profit. (There are a variety of deductions included in this option. Consult your corporate accountant.)
Option 2: 20 percent of the gross sales amount with no deductions.
(Percentages reflect the 2005 Tax Code)

Although a 30 percent capital gains tax may seem high, Mexico does have several laws and procedures that will assist you in maximizing your cost basis, thereby reducing your net profit, and thus lowering your capital gains. The key is to understand these laws before you buy, not when you decide to sell.

Why should you take on the seller’s capital gains liability?

The first step in calculating your capital gains is to subtract the value you have recorded in your trust (fideicomiso) from the sales price of your property. In the past, some real estate companies recorded values lower than the actual purchase price in an effort to “save” taxes for their client. They think they can save money on the 2 percent acquisition tax. This is a big mistake. Never record a lower value than what you actually paid for the property. Doing so simply establishes a lower cost basis for the property, which increases your capital gains tax liability.

An oversimplified example is: You wisely purchase a lot for $1 million, but unwisely record a value of $500,000. In the eyes of Mexican tax law, your cost basis is now $500,000. If you sell the lot for $1.2 million, you see a profit of $200,000. However, according to your recorded cost basis, Mexico sees a profit of $700,000, and your capital gains tax for Mexico will be 30 percent of $700,000 ($210,000.) You just lost $10,000 instead of making a profit.

Rule Number 1: Always record the full value of your purchase.

Realty Executives approach to ownership in Mexico, specifically the trust process, has been established to protect you and provide you with the legal means to safeguard your investment. Recording your real purchase price and proper documentation is the only way to maximize your potential profits. The bottom line is to always secure a trust over your property as quickly as possible for the real value of your purchase.

Never allow anyone to convince you to record a lower value than what you have actually paid for your property, or you will assume the seller's capital gains tax liability. Recording a lower value today can cost you should you decide to sell in the coming years. If a seller can get a buyer to record a lower value, the tax liability simply is passed along, and eventually someone will have to pay. Don’t let anyone tell you “That’s how we do it here.” Mexico is like everywhere else. The capital gains tax is the responsibility of the seller.

It's simple:

1) It isn’t yours until you have the title in your name.
2) If you don’t record the accurate value of your purchase, you’re most likely taking on someone else’s capital gains liability.

Fact: Recording the real value benefits you and establishes your cost basis in the eyes of Mexico.

Fact: The amount you pay for a property has no impact on your yearly property taxes.

Fact: Capital gains taxes you pay in Mexico can be applied to your U.S. taxes.

How do I know if my value is recorded correctly?
You can verify the value yourself by examining the first page of the trust document and noting the amount written in text, which is always in Mexican Pesos. Simply divide the current exchange rate into the peso amount and make sure the result reflects the actual dollar amount you have paid. If you want to check an old trust, simply determine the peso rate for the day and year the trust was executed. We can assist you in finding the exchange rate, as can the bank and the Internet. (Helpful hint: When you sign your new trust, ask the Notary to jot down the exchange rate on the document itself. This will come in handy years later.)

What is inflationary credit?
As soon as you pay your 2 percent acquisition tax to receive your trust, you are eligible to receive an inflationary credit from the Mexican Government for every year you own the property. This credit is added to your cost basis when you decide to sell your property.

The credit is based on consumer index adjustments (inflation) and can be quite significant. We have seen credits in excess of 15 percent per year applied to a cost basis. On a million-dollar property, this can be as much as $200,000 USD per year added to your cost basis, significantly reducing your capital gains tax should you decide to sell in the coming years.

Fact: You are not eligible to receive the inflationary credit unless you have paid your 2 percent acquisition tax.

Fact: You can receive the inflationary credit based on the date of your buy/sell agreement, provided you paid the 2 percent acquisition tax for the property.

What about the two-year capital gain exclusion?
Mexico, as well as the United States, provides its residents a capital gains tax incentive for their primary home. The tax incentive in Mexico states that if you sell your “primary residence” after two years, you pay no capital gains. This law is in place for “residents” (Mexicans nationals or foreigners) of Mexico only, and there are several items required to establish residency status. In order to claim your home as your primary residence in Mexico, you must be able to prove that it really is your primary residence.

At the closing, you will be required to provide the Notary with a residence visa (FM2), as well as a bank account, water, phone and electric bills, paid tax receipts and your trust, all in your name, all with the address of the home and all in place for more than two years.

Fact: You cannot have two primary residences at the same time. Therefore, if you claim the home in Mexico as your primary residence, you give up your primary residency status in the United States.

Fact: The capital gains tax exclusion is intended for residents of Mexico, not for persons owning second homes or vacation homes.

There are no short cuts and no legal ways around taxes in Mexico any more than there are in the United States or Canada. Your home is a large investment, and following proper legal steps will ensure a safe and enjoyable experience in Mexico. If someone says, “This is Mexico, and that’s the way we do it here,” they have just thrown up a red flag and you should seek another agent.

[suzeq]

Thanks for posting that Michelle. It was VERY informative and information that we need to have. Closing on our condo in a week and a half.
Sue

[Opatije]

Thank you posting this...very informative.

I do have one comment though (if you don't mind)...

"An oversimplified example is: You wisely purchase a lot for $1 million, but unwisely record a value of $500,000. In the eyes of Mexican tax law, your cost basis is now $500,000. If you sell the lot for $1.2 million, you see a profit of $200,000. However, according to your recorded cost basis, Mexico sees a profit of $700,000, and your capital gains tax for Mexico will be 30 percent of $700,000 ($210,000.) You just lost $10,000 instead of making a profit."

I think a person would actually loose more than $10,000 on this "deal". Here is why:

Scenario I (purchased lot for $1 million, declared $1 million and sold for $1.2)

Made $200,000 profit and paid $60,000 capital gains. Total value of the deal $1,140,000.

Scenario II (purchased lot for $1 million, declared $700,000 and sold for $1.2)

Made $700,000 profit and paid $210,000 capital gains. Total value of the deal $990,000 (lost $10,000, however the loss is bigger since you've made the decision to lower the initial value of the home to $700,000. The total loss is $10,000 + $140,000 = $150,000)

Clearly, something to consider while making such decisions.

Opatije

[Geoff]

With reference to the gap between the declared purchase value and the sale price, I don't suppose there is any "forgiveness" on properties that were bought some time ago. It the past, it actually was the common practice for buyers and sellers to declare a lower purchase value. Over the last 2 years it seems there has been a push to change this practice. Why can't the private sale contract between the 2 parties be used as the declared price for capital gains calc? The private contract shows the real price paid for the property. We pay for the public notary's stamp on it - and yet it is not a legal declaration of the transaction value? Has anyone tried to put that one through?

[billwarm]

Originally Posted by Opatije

Thank you posting this...very informative.

I do have one comment though (if you don't mind)...

"An oversimplified example is: You wisely purchase a lot for $1 million, but unwisely record a value of $500,000. In the eyes of Mexican tax law, your cost basis is now $500,000. If you sell the lot for $1.2 million, you see a profit of $200,000. However, according to your recorded cost basis, Mexico sees a profit of $700,000, and your capital gains tax for Mexico will be 30 percent of $700,000 ($210,000.) You just lost $10,000 instead of making a profit."

I think a person would actually loose more than $10,000 on this "deal". Here is why:

Scenario I (purchased lot for $1 million, declared $1 million and sold for $1.2)

Made $200,000 profit and paid $60,000 capital gains. Total value of the deal $1,140,000.

Scenario II (purchased lot for $1 million, declared $700,000 and sold for $1.2)

Made $700,000 profit and paid $210,000 capital gains. Total value of the deal $990,000 (lost $10,000, however the loss is bigger since you've made the decision to lower the initial value of the home to $700,000. The total loss is $10,000 + $140,000 = $150,000)

Clearly, something to consider while making such decisions.

Opatije

If you declared for 700k and sold for 1.2M the taxable gain is only 500k?????

[Opatije]

Re: "If you declared for 700k and sold for 1.2M the taxable gain is only 500k?????"

billwarm: You're right...For some reason I used $700,000 as taxable gain where it should read $500,000. It makes the calculation looks like this:

Made $500,000 profit and paid $150,000 capital gains. Total value of the deal $1,010,000 (made $10,000 profit, however the loss is bigger since you've made the decision to lower the initial value of the home to $700,000. The total loss is $140,000 (loss) + ($-10,000 (profit)) = $130,000)

Opatije

[Michele]

Our Real Estate lawyer here in Playa (who I highly recommend) wrote this for a client of ours. I thought it was worth posting.

Mexico has over 8,000 kilometers of coastline, spectacular natural parks, impressive archaeological sites and colonial cities that allows an unlimited tourism development.

In Mexico real state property includes, among others, the land and the improvements of said land.

Mexican Law divides the land in “Finca Rustica” which is the rural property located outside of the city limits, and in “Finca Urbana” which is real estate located within the city limits.

1. The Restricted Zone.

The Mexican Constitution prohibits foreigners from purchasing or owning real estate within the so called "Restricted Zone" which includes the entire territory of Baja California and all other land located within 100 kilometers from Mexico's international borders or 50 kilometers from its coastline.

2. The Federal Zone.

The federal maritime land zone (Zona Federal Maritimo Terrestre) consists of the first 20 meters of beach-front property on firm traversable ground. The 20 meter distance is measured from the high tide line or from the first point above that line where the slope is no more than 30 degrees.

The federal zone is intended to remain public land and to be enjoyed by every person; however, the Mexican constitution allows the government to grant "concessions" for use of the federal zone by means of a concession title.

3. Ejido Property.

The ejido could be defined as an agricultural cooperative that has its origins after the Mexican revolution.

The agrarian law requires the ejido communities to establish procedures whereby their members may obtain private ownership of their respective parcel (pequeña propiedad).

Until such ejido has been incorporated as a group of parcels, the entire property is deemed to be owned by the ejido as a legal entity. An ejido community also may transfer ownership of a portion of its property known as its "common use" property to a partnership, corporation or joint venture in which either the ejido itself or its members participate.

Ejido property is registered in the Public Agrarian Registry and transfers must also be registered with, the Ministry of Agriculture.

4. Foreign Investment in Real Property.

The 1993 Foreign Investment Law (Ley de Inversión Extranjera) allows ownership of "non-residential" real estate within the restricted zone through a foreign-owned Mexican corporation, provided that formal approval is obtained from the Ministry of Foreign Affairs (Secretaría de Relaciones Exteriores).

Otherwise, all foreign individuals and foreign corporations as well as Mexican corporations which include any foreign investment may hold title to property within the restricted zone only indirectly through a bank trust arrangement known as a "fideicomiso".

5. Notary Public.

A Mexican notary public (notario público) (“Notario”) is a licensed lawyer, commissioned as a public notary, fulfilling a public function delegated by the government.

The Notario drafts documents, verifies the facts therein and records the documents with the public registry. The Notario's fee generally ranges between 1% and 2% of the value of the asset and the total amount which the buyer pays to the Notario (including taxes) is usually approximately 6% of the price.

6. Escrow agreements.

Escrow arrangements as we know them generally do not exist in Mexico. It is important to place deposit money with a reputable Mexican or U.S. attorney to be held in a trust account. A bank may also perform this service but will charge a setup fee and a commission based on the amount of money held.

7. Real Estate Loan Documents.

Mexico does not have procedures for nonjudicial foreclosures such as trustee's sales. In general, a borrower's rights under hipoteca cannot be terminated except through judicial process. A foreclosure sale takes place by public bidding.

8. Mortgage Alternatives

Because of the risk that a buyer or borrower, through appeals, may delay the final outcome of a foreclosure process, some sellers and lenders prefer not to use a mortgage. One common security device is the "fideicomiso" where a Mexican bank acting as a trustee ("fiduciario") holds legal title and has fiduciary responsibilities to the borrower or buyer and to the lender or seller.

9. Fideicomiso.

The parties of this bank trust agreement are the seller or the lender of the property ("fideicomitente"), the bank which acts as trustee ("fiduciario"), and the buyer or borrower ("el fideicomisario") which is the beneficiary of the trust.

The beneficiary retains the use and enjoyment of the property, and the trustor agrees not to revoke the trust so long as there is no default.

A fee for registration of the fideicomiso must be paid to the Ministry of Commerce. The amount will vary depending upon the duration of the trust. If foreign ownership is involved, a registration fee also must be paid to the Ministry of Foreign Investment.
In addition, the bank will charge a fee for review and acceptance of the trust, an annual administration fee, a fee for any contracts executed by the trustee, and a fee based upon the recorded value of the property or the sales price.

In the restricted zone, the fiduciario holds the title solely to satisfy the requirements of the Mexican Constitution.

10. Title Insurance.

Certain U.S. companies, however, are now beginning to offer title insurance on Mexican real estate interests to non-Mexican investors and lenders. These title policies will typically have additional coverage limitations which are not common in the U.S., and the cost also will be greater.

It is highly recommended to purchase a Title Insurance, U.S., title insurance is available for properties in Mexico purchased by U.S., citizens.

Under these policies of title insurance, the obligations of the title insurer will be decided under U.S., law and in the United States. Otherwise, the only defense or recourse against title defects is to litigate in Mexico.

11. Title Searches and Title Documents

Title to real property is evidenced by an "escritura publica" which must be signed before a notario and recorded in the local public registry "el registro publico de la propiedad".

An official stamp attached to the last page of a document assures the parties that the instrument has been duly recorded and also provides the necessary filing information.

Title documents will include the chain of title, the meets and bounds description of the property (including, in some cases, the name of the owner of or the nature of abutting properties) and the public registry filing information.

12. Real estate documents and agreements.

In general, contracts relating to real estate (including sales, leases, mortgages, etc.) must be in writing, and the document must be in the form of a public instrument.

A preliminary "promissory agreement" (contrato de promesa) is commonly used as the basic document for a purchase and sale. In the promissory agreement the parties establish their respective conditions, and, upon satisfaction of those conditions, agree to execute a final public agreement, either a sales agreement, a real estate trust, or an assignment of the beneficial rights in a real estate trust.

The promissory agreement, which is a private contract between the parties, should never be used as the final agreement, although by signing it and exchanging consideration the parties do create a binding obligation.

13. Subdivision Development.

A subdivision of land for development purposes is referred to as a "fraccionamiento". A developer must obtain governmental approval in order for them to subdivide the property and, by obtaining such approval, the developer becomes obligated to install the offsite improvements (grading, drainage, water, electricity, streets, etc.).

14. Possession of Land.

Mexican law creates a presumption that the person in possession of property is entitled to continue in possession and has all related ownership rights. This presumption is designed to prevent a breach of the peace. Before acquiring any real estate, it is important to verify that no one is in possession of the property.

15. Time-Share Properties.

Time-share contracts are required to be registered pursuant to federal standards known as Normas Oficiales Mexicanas, which are enforceable throughout Mexico. A time-share purchase, is not considered to be an investment in real estate, and even if the property is located within the restricted zone, a fideicomiso is not required.

16. Condominiums.

Various states of Mexico have adopted local statutes to govern condominiums and these may vary significantly from one state to another. A condominium owner ("condomino") is the individual or legal entity who owns and is entitled to the exclusive right to possession of the premises and has a co-ownership right to the common areas.

The condominium owner's interest in the common areas is proportional to the respective original values of the units as determined in the condominium's title documents. Common walls and floors that separate only particular individual units are deemed to be owned by the contiguous owners.

17. Closing.

Prior to the closing, the Notario will examine documents of the selling party to ensure their accuracy and legitimacy; verifying title; searching the public records to determine the status of seller's title to the property and the existence of liens against the property. The Notario is also responsible for the collection and payment of all applicable property taxes and government transfer taxes.

[Opatije]

Michelle: Thank You for posting this...I do own property in PA and any additional info regarding Real Estate is appreciated.

Opatije

[Styles]

Haha... Tom must have copied and pasted this right from my web-site. EliteInternationalRealEstate

Good info though...

[Michele]

Originally Posted by Styles

Haha... Tom must have copied and pasted this right from my web-site. EliteInternationalRealEstate

Good info though...

You know what they say about imitation...... You and Rob working things out OK without me? Like I said, I do all the pretty stuff.

[Pour Favor]

Had to add one more question on to this thread: We purchased a lot years ago in Playacar and started the fideicomiso based on the lot purchase price. Now we have built a house on the lot so the sale price would be substantially higher vs the purchase price, this means a lot of capital gains tax. Any way around this if you start with just a lot? Should you wait to get the fideicomiso until you construct? That would just make most nervous as like they say "you don't own it until you have title". Seems like building is just not worth it then or you have to live in the home for over 2 years and have a FM2 when it's time to sell. Any advise?

[jwp0077]

Originally Posted by mexcj

you have to live in the home for over 2 years and have a FM2 when it's time to sell. Any advise?

I believe the current restrictions on foreigners to use the capital gains exclusion require that you live in the property for 5 consecutive years and have a valid FM2. Check with a notario (maybe several of them) to get the best advice.

[jwp0077]

Here is a link to the 2007 tax changes -


http://www.sat.gob.mx/sitio_internet.../134_9008.html

[robinne]

hi all,

thank you for posting all these illuminating stuff. Not from mexico but am looking for insider info (esp. from locals) you can't really find in regular websites but in the forums. i'd say this is one of those that rock.

robinne

[Michele]

Some more good info.

OWNING REAL PROPERTY IN MEXICO REQUIRES SPECIAL IRS FORMS IF YOUR PROPERTY IS A RESIDENCE OR IN FEDERAL RESTRICTED ZONE
(This is also true if you are beneficiary or creator of any foreign trust including a fideicomiso)

By Don D. Nelson, CPA, Attorney, CPA

If you, as non citizen of Mexico, own a home or other residential real property located in the "restricted zone" close to the coast in Mexico, the Mexican constitution has been construed to require that you own it in a bank trust called a "fideicomiso." The Mexican bank acts as trustee and you as the equitable owner of the real property are the beneficiary. The trust has a term of 50 years and can be renewed thereafter.

Under US tax law the fideicomiso meets the definition of a "foreign trust." That means you are required to file Form 3520 when you initially establish the fideicomiso or foreign trust and the trustee is to file Form 3520A for each year thereafter. The Form 3520
must be filed with your tax return, while the Form 3520A is due on March 15 of each year, though you can apply for an extension of time using Form 2758. These forms must be filed for any foreign trust controlled by a US citizen or those of which a US citizen are the beneficiaries. This includes "asset protection trusts" in many situations.

Some international tax professionals have argued that the fideicomiso is not really a trust but is an agent for holding title to real property in Mexico. Recent discussions with an IRS International Division Counsel has reaffirmed that the IRS considers Section 6048(a) to apply to fideicomisos as used in Mexico and Form 3520 and 3520A should be filed. They have indicated they have no current plans to issue any future rulings on this subject.

Items that are required to be included in the 6 page Form 3520 include:

§ The name and address of the trustee and all beneficiaries

§ The value of the property and money transferred to the trust

§ Distributions from the trust

§ Copies of Trust documents

§ The name of any US agent appointed for the trust, etc.

If you fail to file Form 3520, there is a penalty charged equal to 35% of the value of the property transferred to the trust, or of any unreported distribution. This penalty can be waived by the IRS for reasonable cause (which has not been clearly defined). The IRS has issued no guidance with respect to what is considered reasonable cause for failure to file Form 3520 and 3520A for a Mexican fideicomiso. Therefore any taxpayer that has failed to file this form and continues to not file this form is at great risk of potential past, present and future penalties.

The Form 3520A reports each year's income and expenses for the trust. It includes a year end balance sheet for the trust and information on distributions made to beneficiaries. The US owners or beneficiaries of the trust are subject to a penalty of 5% of the trust's gross asset value for failing to file this form. Penalties can be waived for "reasonable cause" but as stated above, what that reasonable cause is has not been defined by the IRS.

If you purchase property in Mexico outside of the "restricted zone" you probably have title in your name and are no required to file these forms. The same holds trust if you purchased commercial property using a Mexican or foreign corporation. However, you should be aware that as a US Citizen, you are required to file Form 5471 each year with your tax return if you hold a 10% or more interest in a foreign corporation any where in the world.