VIEWPOINTTM

Capital gains tax in Mexico
By Harriet Cochran Murrray - Cochran Real Estate - August 2007

“The only things certain are death and taxes.” Anonymous

There has been much discussion on the tax changes in effect since the end of last year.  I have wanted to write about this subject, but only after I had information from a source I felt was knowledgeable and thorough.

David Connell, an American with a Mexican law degree and real estate practice here in Mexico, spoke to a group of AMPI members this past week in Puerto Vallarta.

Here is a summary of his class:

The Mexican government through its Constitution, International Treaties, and Fiscal Code, addresses taxes from the basic premise that all persons residing or owning property in Mexico should pay some tax.  As residents in the United States of Mexico, persons should pay toward the services provided where they are enjoying benefits and services.

Article 9 of the Constitution classifies Residents and Non-Residents as the two categories of persons living in the country.  Only Residents by legal definition are eligible for waiver of capital gains.

A residence is a tax resident whose home in Mexico meets the test of being their “center of vital interest.”  To be considered for exemption from capital gains tax or eligible for a lesser amount of tax, the resident must live where he makes most of his income……more than 50% of his income comes from Mexico. The retiree whose income is from outside the country, can be considered meeting the waiver test by the notary if he has been in his primary residence in Mexico for 5 prior consecutive years and has an FM2 or Immigrado status.

Let’s go back to when this tax issue comes up: upon a sale.  The traditional sale of signing over a deed upon payment of the purchase price is not the only transaction considered a sale by the government.  A reserve of domain is considered a sale, as is the transfer of a corporation or transfer of a fideicomiso trust escritura to another party.

The sale triggers a tax of capital gain, or establishment of an exemption.  Currently, a legal resident must have been in his home for 5 consecutive years.  Legal paperwork and utility bills such as electric, hard line telephone, bank statements, or voter id, must conform to the exact address and ownership as defined in the deed.  For a foreigner, an FM2 is what some notaries are using for evidence of primary fiscal residency as a seller. Note that cellular phone bills are not considered evidence of residency requirements.

The discussion of FM2 and FM3 brings up the issue of Migratory Status:  An individual is an Immigrant or a Non-Immigrant.  Under Immigrant status, according to Article 14 of the law, a foreigner must have either an FM2 or Immigrado status.  An FM2 is an option to acquire on the 6th consecutive year after a foreigner or extranjero has had an FM3 for five prior consecutive years.  There are additional requirements of being in the country for a certain amount of time before being eligible to obtain an FM2. Also, once an extranjero has an FM2, they cannot drive a foreigner car, as in Canadian or US plated car.

 Immigrate status can be obtained by a foreigner after years of living in Mexico and meeting a list of requirements.  When this status is achieved, the foreigner, now immigrado, may work or reside in Mexico without a visa permit and not pay yearly fees to renew a migratory status under an FM2 or FM3.

Visas under the category of Non-Immigrant Status are an FM3, or the tourist card given for shorter visits to Mexico, which is also a type of FM3.  If you can’t meet the residency requirement as a foreigner or national, you cannot take the position that you own a residence eligible for exemption or lesser capital gains tax.  Nationals not residing in the country with their majority of world wide income not coming from Mexico cannot waive capital gains taxes for a property owned in Mexico.  The law treats the end result for either foreigner or national the same.  One can say that the requirements for a foreigner to be eligible for waiver of capital gains are more numerous.

Foreigners living off of foreign income while residing in Mexico are legally classified as Rentistas.  Retirees are many times in this category.

So suppose you are not eligible for the exemption, but meet the test of living in Mexico in a home you own which is your “center of vital interest” and is your main residence, as well as your fiscal residence. Perhaps you are selling and you have not been in the home for 5 consecutive years and you have an FM2. Here are your options for selling at this time:

You may declare approximately the first $500,000US of the sales price as a deduction from the full price.  The amount of the deduction is figured every day in a monetary unit called a UDI in Mexico pesos.  The daily conversion between pesos and US dollar equates to around $500,000USD at this time.  Taxes are computed with the amount owed on the amount over the $500,000USD deduction.  A percentage of deductible expenses may be allowed as deductions before the tax is paid.  The balance is taxed at 28%. 

The effective tax paid, compared to the purchase price, can be less than a straight 28% of the difference between the basis and the sales price.  You can use allowable deductions such as permanent improvements with a factura (official tax deductible receipt) or the real estate commission with a factura including the 15% iva. Iva is a value added tax on goods and services and is a large source of tax income for the government.

If the home is undervalued on the current tax rolls, there are cases that a request for reevaluation can be made to the tax authority.  When this is properly done, the basis for tax can be increased legally. 

If a seller does not meet the fiscal residency requirements with his property, then the tax is a straight 28% of the difference in the basis or price declared in the escritura and the sales price.  The basis can be increased by use of the CPI or inflation index during the period of time the property has been owned, less depreciation.  Adjustment for inflation shall not exceed 10% of the value of the sale.

No one may claim more than one capital tax exemption in each calendar year.

In order to prevent abuses of large land owners with homes desiring to claim the entire property exemption, there is Article 109 in the Law.   The land exemption cannot exceed 3 times the foot print or perimeter of the home.  Land in access of this computation is not exempt and is taxed at the 28%.  Land with no habitable dwelling on it is not exempt.

In the case of older escrituras with no break down of the land and structure separately, the basis for taxation is taken with land at 20% and construction at 80% of the total amount declared in the deed. Depreciation of the construction can be up to 3% per year.

In the case of homes never manifested when built, it is important to have the dwelling registered as a completed and to declare the real value paid.  This value becomes the basis for the tax computations upon sale. In the past, too many owners did not manifest or register their construction in order to avoid a small amount of higher tax.  Later the owner faces fines as well as more capital gains tax because he has been “penny wise and pound foolish.” 

In construction, it is also important to pay other expenses and taxes in order to avoid ongoing liability.  These necessary payments are a business license for the construction, notice of termination of construction, and finalization or a finiquito of social security for the construction workers. Be sure you or your builder pay these obligations and that you have original, correct receipts. 

For properties classified as non-residences, such as property owned by a company or purchased for investment, the tax is either 25% of the full price, or 28% less deductions.  Most of these sellers opt for the second option to save on tax. Nationals do not get an option of 25% of the purchase price for tax.

It is very important to realize that the notary charges and shows the capital gains tax collected at closing as a provisional payment. The seller is required to file at the end of the year and any adjustment will be figured then.  Don’t forget to do this.

If a seller is granted exemption of capita gains tax in a calendar year, he is required to report this by March of the following year. Remember to do this.

All these tax and residency rules apply to extranjeros and nationals alike.

The tax payment made in Mexico counts as a credit for Americans against their US tax liability if there is one.  Canadians do not get a credit but pay Canadian taxes as if none were paid in Mexico.  Mexicans pay their tax in Mexico.

You can ask the notary to give you his computation for tax and you can double check it for mistakes.  Some sellers hire an attorney or accountant to double check the method and math of the taxation the notary has come up with as a charge.  There are cases where the amount is challenged and accepted.