THE INTERNATIONAL TAX ADVISOR

by:  Douglas J. Kingston, CPA/MBA  • Mailing Address: 16443 N 59th Place; Scottsdale, AZ 85254

• Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/

MEXICAN TAX ASPECTS OF U.S. INVESTMENT IN MEXICAN REAL ESTATE

 

Background

 

 

Mexican Taxation of Rental Activities

 

 

Mexican Taxation of Disposition Gain

 

 

Taxes Other Than Income

 

Concluding Advice

 

 

Sample Picture

 

It is important for U.S. investors to consider both Mexican and U.S. tax issues in planning to acquire Mexican real estate.

 

Background

 

Under Mexican law, foreigners may acquire direct ownership of real estate in the interior of Mexico but may not acquire direct ownership of residential property within the “restricted zone” (approximately 62 miles from the border and 31 miles from the coastline). However, foreigners may acquire exclusive beneficial rights to residential property in the restricted zone through a bank trust or “fideicomiso” authorized by the Mexican government. The bank trust is established for a 50 year renewable term and grants the beneficiary the right to use, rent, modify, or sell the property.  The foreign beneficiary may be an individual, corporation or other legal entity. For tax purposes the trust is a flow-through entity; that is, the beneficiary is treated as the taxpayer. Commercial property may be acquired by foreigners without a bank trust provided the property is held through a Mexican corporation with restrictive by-laws. Foreigners may own 100% of a Mexican corporation unless it is engaged in one of several restricted industries.

 

This article summarizes the Mexican tax consequences of acquisition, operation and disposition of real property located in Mexico by a U.S. resident individual or entity.

Mexican Taxation of Rental Activities

 

Mexican taxation of rental income follows the general rule that a foreign owner’s income is subject to tax on a gross basis (i.e., without deduction of expenses). Rental income from property located in Mexico is subject to a 25% tax withheld at source (i.e., the tenant or management company remits 25% of the rental payment to tax authorities and the remaining 75% is paid to the foreign owner). A reduced tax rate of 2% is provided under the so-called “small taxpayer system” for individuals with annual income below a threshold amount. Tax withheld on rental payments from nonresidents must be paid over to authorities within 15 days.

Under the Mexico-U.S. tax treaty, a U.S. resident may elect to be taxed on a net basis (i.e., with deduction of expenses). An electing individual’s net rental income is taxed at graduated rates from 3% to 30% (the top bracket begins at approximately $US8,500). An electing corporation’s net rental income is taxed at a flat rate of 30% (Mexico does not impose a tax on dividends attributable to net profits taxed at the corporate level).

 

Allowable rental deductions include ordinary and necessary expenses such as property tax, interest, management and maintenance expenses, as well as depreciation on building and improvements (computed on a straight line basis over 20 years for buildings and 10 years for furniture and equipment, adjusted for inflation). All deductible expenses must be properly documented and any withholding taxes relating to the payment of deductible items must be paid to the appropriate tax authorities. In lieu of itemizing actual expenses, taxpayers may elect to deduct a fixed percentage of gross rents: 50% for residential property or 35% for commercial property.

Mexican Taxation of Disposition Gain

 

A foreign individual or corporation selling Mexican real estate is subject to a 25% Mexican tax levied on the gross sales proceeds. Alternatively, the taxpayer may elect to be taxed on inflation-adjusted net gain at a flat rate of 30% (provided the sale is properly recorded, a return is filed and a fiscal representative is appointed - the representative must either be resident in Mexico or resident abroad with a permanent establishment in Mexico).

 

Mexican Taxation of Disposition Gain (cont’d)

 

Gain on the sale of an interest in a Mexican corporation is subject to tax if Mexican real estate accounts for more than 50% of the company's book value, or if the seller directly or indirectly owned at least 25% of the company’s capital during the prior 12-month period.

 

If the net gain election is made, and if the property is sold to a buyer resident in Mexico, the buyer must withhold from the purchase price and remit to authorities 25% of the sales price as a tax prepayment.  If the election is made and the buyer is not resident in Mexico, the foreigner must file a return and pay any tax due within 15 days of disposition.

Mexican law makes no provision for tax-deferred arrangements common in the U.S. such as installment reporting or like-kind exchange with respect to real estate transactions.

 

Taxes Other Than Income

 

Although income and most other taxes are levied only by the federal government, each Mexican state has jurisdiction to impose a real property transfer tax. Transfer tax is paid by the person acquiring property and rates very among the states from 2% to 3.3% of the property’s market value – a notary fee of approximately 1% of the value of the property may also apply. Taxable transactions typically include transfers that occur by reason of purchase and sale, donation, death, or contribution to, distribution from or reorganization of a legal entity.

 

The Mexican states also impose annual property tax based on the property’s assessed value at rates ranging between 0.4% to 1%.

 

Mexico generally imposes an annual “business assets tax” of 1.8% of the value of assets used in conjunction with business or commercial activities conducted in Mexico. However, excluded from the tax are rental activities of individuals not engaged in business through a fixed base or permanent establishment in Mexico where the property is rented to persons not subject to Mexican income tax.

 

Mortgage interest paid to a U.S. lender is subject to Mexican withholding tax at rates between 4.9% and 15%, but only if: 1) the borrower is a resident of Mexico, or 2) the borrower incurs and deducts the interest expense in conjunction with business he carries on through a fixed base or permanent establishment in Mexico.  Although the withholding is a tax on the income of the U.S. lender, the borrower is liable to Mexican authorities for any unpaid tax. Also, under the terms of most cross-border loan agreements, the borrower is usually held responsible for the cost of any withholding tax.

 

Mexico imposes no gift, inheritance, or wealth taxes at either the federal or state level.

Concluding Advice

 

An investor in Mexican real estate is well advised to seek reliable tax planning assistance and properly structure the investment in order to minimize both U.S. and Mexican taxes (for example, by ensuring deduction of costs in both countries and maximizing utilization of foreign tax credits). In addition to matters of taxation, investors should consider the significant costs of setting up and maintaining any required bank trust and obtaining adequate title insurance and a Mexican notario, as well as other issues such as the impact of foreign currency fluctuations and political risk.

Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by:

Telephone: (602) 595-5885E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/