Capital Gains Taxes on Mexican Properties

yucalandia.com

April 28, 2014 Update

Mexico’s tax code on property taxes changed dramatically in February 2010, and again this past 6 months (Nov. 2013 law taking effect on Jan. 1, 2014).

The changes nullified most internet advice given before February, and makes much current internet advice suspect.   This article addresses some of the current tax requirements and rules,  and it also addresses the tax differences between Visitante, Residente Temporal, and Residente Permanente INM Residency Card options.

The key Mexican statutes addressing these issues are Article 109. XV. of La Ley del Impuesto Sobre la Renta (ISR) and Art. 93 – Frac. XIX.

March 2014 Update:

The Mexican government changed the tax rate on net gains (now 35% of net gain), and they changed the rules on the requirements for being classified as a resident of Mexico for tax purposes – a key requirement to qualify for the Homeowners Exemption to paying gains taxes on selling a home you have lived in for 5 years as your PRIMARY/PRINCIPAL RESIDENCE: Condición para acreditar que las personas físicas de nacionalidad extranjera que enajenan su casa habitación son residentes en México para efectos fiscales: I.3.10.13.These instructions describe that the foreigner is a resident in Mexico for tax purposes, when the following requirements are met. They must certify under oath:
“I. Declaren, bajo protesta de decir verdad, lo siguiente:
a) Que tienen la condición de residentes en México para efectos fiscales, en los términos del artículo 9, fracción I del CFF y, en su caso, de los tratados para evitar la doble tributación que México tiene en vigor.
b) Su domicilio fiscal o, en su defecto, un domicilio para oír y recibir notificaciones. En ningún caso el domicilio señalado podrá ser o encontrarse en la casa habitación que enajenan.
II. Adicionalmente a lo anterior, acrediten su condición de residente en México. Para tales efectos, se considerará que se acredita dicha condición con la constancia de residencia para efectos fiscales a que se refiere la regla II.2.1.4., o en su defecto, con la cédula de identificación fiscal referida en la regla I.2.4.2.
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Cuando la persona física que enajena su casa habitación no sea residente para efectos fiscales en México o no sea residente para efectos fiscales en el extranjero con establecimiento permanente en el país, no será aplicable la exención establecida en el artículo 93, fracción XIX, inciso a) de la Ley del ISR. En este supuesto, los fedatarios públicos, que por disposición legal tengan funciones notariales, estarán a lo dispuesto por el artículo 26, fracción I del CFF, respecto de la enajenación de que se trate, debiendo calcular y enterar el impuesto en los términos de lo previsto en el artículo 160 de la Ley del ISR.
CFF 9, 26, LISR 93, 155, RCFF 5, RLISR 130, RMF 2014 I.2.4.2., I.3.10.6., II.2.1.4.“

Crudely translated:
I declare under oath, to tell the truth:
(a) that he is a resident of Mexico for tax purposes, under the terms of article 9, section I of the CFF and, where appropriate, of the treaties to avoid double taxation that Mexico has in place.
(b) he has a tax home Mexican address to receive notifications. In any case the designated home that is being sold should not be the home address claimed for tax purposes. …

In theory, this should open the door for Notarias to approve foreigners who are not Mexican citizens to qualify for the homeowner’s exemption.

Much past advice on the internet implied that  if you got an FM3 or FM2, or a Residente Permanente,   then you could automatically save on a future Capital Gains taxes   when   you sell your property.      This was not true in the past, but   may   work for Residente Temporal and Residente Permanente INM Residency card holders – if   you can find a Notaria who accepts this new I.3.10.13. ruling.*

Further: Advice that worked before Feb. 2010, or  before  Nov. 9, 2012,    no longer works since the rules have changed   dramatically raising the bar of requirements   for foreigners to qualify for the current 5 year Primary Residency requirement for an exemption to Capital Gains taxes.

The tax calculation & tax status-determination of property sales by foreigners is a murky and dense area in Mexican tax law.   Prior to the March 2014 rule change: It was reported that many/most Notarias across Mexico believe that foreigners with FM3′s (equivalent to the new Residente Temporal) did not qualify for the Mexican Residents Primary Residence home-owners capital gains tax exemption**.

*Since each Notaria is personally financially liable for individual choices they make for each client,  many Mexican Notarias were  not  willing to approve foreigners with FM3′s (Residente Temporal) even if they met the 5 year Primary Residence requirement, and individual Notaries still may reject even Residente Permanentes when choosing to grant the Primary Residence 5 year home-owners exemption.

It is worth pointing out the March 2014 rule change to the Notaria handling the sale, to find out if they have a policy of denying foreigners this exemption.   Note that in some parts of Mexico, the home Buyers like to choose the Notarias – and their Notario (or the Bank Notario for mortgaged properties) may not be willing to grant the exception.
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**Property Sale Capital Gains Tax (ISR) Exemption Requirements: **
ISR Tax Law has 3 major options for determining property sales taxes on the gains:

1. No taxes are owed on sales of the owners primary residence, when sold after 5 years by qualifying residents of Mexico (Primary Residence exemption).    or
2. 25% of the Gross Sales amount.     or
3. 35% gains tax on the net profit/gain (reduced by various deductions and depreciation)***.

Item 1: Fully Exempt from Capital Gains Taxes:
To qualify for the 5 year Primary Residence exemption, you have to meet a number of requirements:
~ * ~  Mexico has to be your “fiscal residence” & the “main center of your professional activities”, etc. for 5 years.
~ * ~  In attempting to qualify as a Mexican Resident for tax purposes, you must have 5 years of CFE or JAPAY bills in your name.
~ * ~   The property cannot be used for income generating purposes within the 5 year residency period.
~ * ~   Some Notarios were accepting property sales tax exemptions for only a few foreigners who had FM2′s.     Many Notarios have required that the foreigner must have applied to become naturalized citizens of Mexico to qualify for the exemption – but since the March 2014 rule-change, THIS IS NO LONGER THE LAW.  (see the details in the “March 2014 Update” above).  Still: Since Notarios stick-out-their-necks financially, they can add their own personal requirements that are not spelled-out in the law/regs.

This means that getting a Residente Permanente   does not   ensure that your Notario (or any Notario) will approve your claim for the 5 year Primary Residence exemption, but the Notario has the legal option to approve the claim.

If you really want to be exempt from 25% taxes on the FULL SALE PRICE of future property sales:    Expats buying Mexican properties and owning properties really must find and hire a Notaria who agrees,  in advance,  to support their hoped-for claim of the 5 year Primary Residence exemption.

~ * ~   It is best to be sure your Notario agrees that you meet the requirements, and that he is willing to approve your application for the primary residency exemption, before you plan to try this.

~ * ~   If you own a property using a Fideicomiso or a mortgage, you may be trapped into whatever policy your Bank’s Notaria chooses.   e.g.   In the worst case:    The Bank asFideicomiso trustee, and their Notaria,  can refuse to accept your proposed sale of your property,  unless you pay 25% of the full sales price.

….  This works out to be $178,000 USD in taxes on a $9 million peso property sale  in one Yucalandia reader’s experience.  (with NO deduction of even the original sale price) ….

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Notes:   ~ If you do not qualify for the Homeowner’s Exemption, you can use facturas for improvements to reduce the gains.   If you do not have facturas you can request a special tax appraisal that can be done to raise your basis and lower capital gains exposure.

~  With the new tax reforms, ISR is capping the amount we can exempt at 700,000 UDIs (UDIs are an index which is currently about 5.02). Further if your property is sold for less than one million five hundred thousand “investment units” (UDI’s) (which was approximately $550,000 USD), then the rules described in this article apply.

If you are a “Fiscal Resident” and the amount of the sale exceeds the above amount, you will pay tax on the amount that exceeds the exemption (550,000 USD) “proportionally to the amount that results from dividing the amount that exceeds by the total amount of the sale”.

Don’t we all love govt. legalese?     Let’s cut through that knot with a practical example:

For a purchase price of $300,000 dollars  and a sale price of $ 1,000,000 dollars:

$1,000,000  – $ 550,000 (the exempt amount) =  $450,000 (net taxable income),

The net gain of $450,000 is 45% of the total sales price.   This means you can only apply 45% of your purchase price (this would be 45% of $ 300,000) as  the “cost” =>  $135,000.

The  $450,000 (taxable gain)   -  $135,000 (adjusted basis/cost)  = $315,000 final net basis.

This $315,000 is the amount over which your tax will be calculated.

~ Clear as mud? ~

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NOTE.- The exemptions reported above only apply to the sale of one home per year.

Remember:  If you are the “Fiscal Resident” in the home for more than 5 years, the sale of the home is exempt, regardless of the UDI and other complex calculations.

CLARIFYING NOTES:

1. Exemptions only apply to construction and on land only “up to 3 times the area covered by the construction.”   When claiming the exemption, the value of the construction and land must be separated when the land area is more than 3 times the “footprint” of the construction(s).  This existing tax rule is applied by some Notarios, but this rule can be contested and won, making the entire sale exempt. Sharp attornies recommend getting a second opinion on this,  if your Notario makes it an issue.
2. Even though we qualify for the homeowner’s exemption from the gains tax, we must declare income on our Mexican annual filing for any residential sale that is over $500,000 pesos.     ~ Clear as mud? ~

This also means that after January 1, 2014 we can exempt from payment of capital gains tax a gain of up to $3,500,000 pesos, but any gain over that amount will be taxed.

~ Remember that if your land is more than 3 times of your building footprint** you will pay capital gains tax on the sale.   Thanks to Lic. Spencer McMullen for these updates.

~ **Finally, note that SAT/Hacienda’s makes the default decision that the land is worth 20% of the total sales price, and that the constructions/buildings are worth the remaining 80%.

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Further Notes: (for Item 3)
***Capital gains reductions include a 3% per year inflationary credit that reduces the property’s basis every year (10 years of ownership = 30% reduction, but I understand that there is a 5% floor of minimum taxes or minimum 20% Basis of the original listed sale price).

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Basis Calculation for    35% tax on net profits   gains calculation:

Income/Selling Price – Purchase Price – Deductions = Net Taxable Gain

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***Here are a few of the Mexican tax laws  other  arcane factors in determining the amounts of Capital Gains taxes under Item 3:

* Raw land is taxed differently than improved properties;
* The tax exemption is only on the buildings and the land covered by the buildings (- see the details above);
* Corporations are treated differently than private owners;
* Properties valued under roughly $500,000 USD are treated differently than properties over $550,000 USD (actually using a $1,500,000 peso “UDI”) – sort of a luxury tax;
* There is a 3% per year inflation adjustment on the basis, but you only qualify if you paid the 2% Acquisition Tax at the time of sale (this can give a net 30% tax savings at the time of the sale);
* The 2% Acquisition Tax is an allowed deduction;
* The construction’s costs (building’s basis values) depreciate 3% a year and can not exceed 20% of the initial purchase price, while the resulting cost (basis) will be adjusted up for inflation;
* If your improvements exceed 20% of the purchase price, you need to get your local property tax authority to come and re-value / re-assess your property. Our Yucatan office is called “Catastral”.
* The improvements that imply deductible investments will be subject to the same depreciation treatment, and must be count with its respective documental support (Facturas in seller’s name) – no wonder businesses give you the option for Facturas…
* Maintenance costs are not deductible expenses;

* If the expat has held an FM-2  or  Residente Permanente for the past five years, they can apply for Mexican nationality, and then ask their bank to convert the FTD contract to an “escritura”, thus acquiring Real Rights on the property which will enable them to claim the Primary Residency’s capital gain exemption at the time of the sale.

* ~ If you do not qualify for the Homeowner’s Exemption, you can use facturas for improvements to reduce the gains.   If you do not have facturas you can request a special tax appraisal that can be done to raise your basis and lower capital gains exposure.

* ~  With the new tax reforms, ISR is capping the amount we can exempt at 700,000 UDIs (UDIs are an index which is currently about 5.02). This means that after January 1, 2014 we can exempt from payment of capital gains tax a gain of up to $3,500,000 pesos, but any gain over that amount will be taxed.

* ~ Finally, remember that if your land is more than 3 times of your building footprint, you will likely pay capital gains tax on the sale – unless you find a Notario who knows the details of the law.   Thanks to Lic. Spencer McMullen for these updates.

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Because Mexican tax law is so dense and arcane and parts of it change roughly every 2 years,      when buying or selling property in Mexico, it really is best to consult with a good tax lawyer and a Notario to find out how things work in your state or locality under current laws.    Also:  Feel free to seek second opinions, because many Notarios do NOT know the current law and recently updated rules.  If your property is held in a Fideicomisotrust, then, definitely find out in advance what your Bank’s Notario allows.

Mexican tax law is a specialty area within the law, an area where Notarios are not the experts, so, taxes on property sales is one spot where you may likely need both a Notarioand a separate tax lawyer (abogado) to accurately determine and pay the lowest legal taxes.

Finally, it is also worth noting that the tax is actually not a “capital” gains tax, but just a tax on gains, and the taxable value is based on the purchase price shown on the bill of sale:

NOTE: When many Mexican sellers list a low price on the bill of sale – with cash payments on the side to make up the balance – they have shifted the taxes THEY OWE ~ over to you to pay for them ~ as future gains taxes when the new owner ultimately sells the property.

Clear as mud???

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Disclaimer: This information is not meant as legal advice. It is for educational and informational purposes only. Government policies vary between States and offices, and Mexican Government officials have broad discretion in how they individually enforce policies, so, your personal experiences may vary. See a professional for advice on important issues.

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YucaLandia/Surviving Yucatan.
© Steven M. Fry