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In ever-increasing numbers, Americans are discovering the dramatic economic and lifestyle benefits of owning real estate in Mexico. Many people who start out wondering if it is even possible to own Mexican real estate end up, a year or so later, watching a perfect ocean sunset from the comfort of their modern, safe, and completely legal Mexican home. Getting to that sunset view is a process which quite understandably involves a lot of questions and a learning curve. This article answers some of the questions you (and your tax consultant) may have about the US income tax implications of owning real property in Mexico.

IRS Requirements for Fideicomiso Beneficiaries

The Ownership in Mexico section of the Emerald Coast website describes the fideicomiso1 This is a perpetually-renewable beneficial trust in which a Mexican bank holds the deed as legal owner, while the beneficiary of the trust (you) enjoys all rights of ownership, including the right to sell, lease, encumber and pass the property to heirs under US law. The IRS treats fideicomisos as foreign trusts within the meaning of Section 6048 of the Internal Revenue Code. If you own your Mexican real estate in a fideicomiso, you are subject to the filing and reporting requirements of Section 6048.2

To comply with Section 6048, file an annual Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) and Form 3520-A (Annual Information Return of Foreign Trust with a US Owner).3 These are information returns. The obligation is to report activity in the foreign trust. Since fideicomisos, unlike most trusts, do not generate income, the only US income tax obligation arising from ownership of Mexican real estate in a fideicomiso is to file Forms 3520 and 3520-A.

If you hold title to Mexican property outright, as opposed to being the beneficial owner through a fideicomiso, you are not subject to these filing and reporting requirements. The requirements, however, are neither difficult nor expensive to comply with, and there is no reason to avoid the fideicomiso form of ownership because of IRC 6048. In fact, fideicomiso ownership has many advantages and is recommended for most people.

Entity Ownership Of Mexican Real Estate

US entities can be the beneficial owners of Mexican real estate in a fideicomiso. The form of entity you choose will be a matter of the law of your state. In Colorado, for example, the limited liability company (LLC) is a popular choice. Consult your attorney to discuss the pros and cons of the various forms of entity available in your state.

US Income Tax Treatment For Your Mexican Home

In addition to filing Forms 3520 and 3520-A, additional US income tax obligations may arise, depending on how you use your Mexican home. As long as you are a US citizen, you are subject to US income tax obligations, even if you live in Mexico. Contrary to what you might read, living out of the US does not relieve you of your US tax obligations. Only giving up your US citizenship does that!

If you use your Mexican house as a second home, and you don’t rent it out or use it to generate any income, the IRS treats it as a vacation home. Real estate taxes, casualty losses, and mortgage interest are deductible on your US federal income tax return (see 26 U.S.C. Section 280A).

If you use the house yourself and rent it, you can still deduct rental expenses, if you stay in the home yourself for less than 14 days per calendar year or less than 10% of the number of days per calendar year in which you rent the home. How much rental income is includable as income on your US tax return, and how depreciation, maintenance expenses, operating expenses, mortgage interest, property taxes, and insurance are allocated between personal use and rental use on your tax return depend on how many days the property is used for each purpose (see 26 U.S.C. Section 280A4).

If your Mexican property is strictly a rental, the same rules apply as for US rental real estate. You can take deductions on Schedule E of your US federal income tax return for mortgage interest, insurance, operating expenses, repairs, and maintenance, and you can offset those expenses against gross rental income.

If you “actively participate” in the management of the property, you may be able to use up to $25,000 of real estate losses to offset other income on your US tax return. However, this benefit only applies if your adjusted gross income is $150,000 or less.

If your Mexican home is your principal residence, you can take the same deductions that apply to a US principal residence. You can also deduct foreign property taxes (see 26 U.S.C. Section 164(a)(1)(3)).

Mexican Tax Issues

If you generate income in Mexico, for example by renting your Mexico house, you need to report that income on a Mexican income tax return. You do not have to pay double taxes, thanks to a tax treaty5 between Mexico and the United States. (You don’t have to pay tax to both countries, but you still have to report the income to both countries. You pay income tax to one country, then take a credit in that amount on your return in the other country.)

In other words, if you rent your Mexico house, you’ll need a Mexican accountant. Many good ones are available. I recommend using one with existing American clients who is already familiar with the particular issues pertaining to the filing of Mexican income tax returns by non-Mexicans. Another alternative is to hire a Mexico-based property management company. For a fee, they will take care of everything, from renting to taxes, so you don’t have to sweat the details.

Other US Tax Issues

Besides income tax, you may also want to consider US estate and gift taxes. Under current US law, if you are a citizen or resident of the US, your Mexican real estate will be included in your gross estate for tax purposes whether you hold title to the property outright or in a bank trust (see 26 U.S.C. Section 2033). If you give your property away, say to a family member, or allow them to live there rent free, these are considered gifts. If the annual value of the gifts is greater than USD $12,000, you will be subject to gift taxes (see 26 U.S.C. Section 2503(b)). Consult your tax preparer or financial planner to make sure you get the full benefit of your Mexican investment.

Selling Your Mexican Real Estate

If you decide to sell your Mexican real estate, report the gain to your US tax preparer. It will be treated as a capital gain. Of course, if the house was your principal residence for at least two of the last five years, US law allows you to exclude realized gains up to $500,000 for married couples filing jointly, or $250,000 for single taxpayers (see 26 U.S.C. Section 121).

There is also a capital gains tax in Mexico, although under Mexican law, you may qualify for a capital gains tax exemption (also sometimes called a homestead exemption) on the sale of your Mexican real estate. In 2002, the Mexican government eliminated the requirement that you live in the home for two years before it can qualify for the exemption. Now, a series of factors determines whether you get the exemption, and the decision of the Notaría working on your sale is critical. Consult a Mexican lawyer or tax preparer before you purchase your property if you are planning to resell your Mexican home.

Summing Up

The best way to handle the US and Mexican tax implications of buying a home in Mexico is often to delegate the details to legal and accounting professionals on both sides of the border. And remember: that sunset is waiting for you.

The author, Mark Apelman, is an attorney and partner in Boyle/Apelman PC, a Denver-based law firm with a national and international practice. He owns a home in Mexico and has enjoyed traveling to Mexico for more than 30 years.

If you wish to discuss your specific situation, please feel free to contact the author.

This article is not legal advice and should not be construed as legal advice. Every situation has its own particular facts and nuances, and only within the personalized and privileged context of an actual attorney-client relationship is it possible to give legal advice.

This article assumes that you are a US citizen. If you are a citizen of Canada or any country other than the US, or a dual citizen of the US and Mexico, consult your lawyer or accountant.

Estate Planning and Overseas Investment Resources

For additional resources, click here for the IRS Living Abroad Tax Guide.

Click here to contact Mauricio Calderon, a public accountant and tax specialist with more than 38 years of local experience, who has served as a consultant to the public prosecutor. He is an accounting and taxation consultant for Emerald Coast.

Click here for Glazer Financial Network. This full service financial services firm offering investment, retirement, and estate planning, tax preparation, accounting and bookkeeping services, insurance, and benefit programs, with particular expertise in issues facing overseas investors and residents.

Click here for American Citizens Living Abroad. This website contains a wide variety of useful tips for expats, including tax information and other up-to-the-minute news.

Other Useful Tax Facts

  1. Similar to European countries, Mexico has a national sales tax (VAT) of 15%. The sale of land and residential property is exempt.
  2. Residents of Mexico are subject to Mexican taxation (including overseas income) based on an annual income tax return. Tax is charged on a progressive scale, up to a maximum of 35%. US citizens receive a credit for foreign tax payments.
  3. Buyers of real estate are subject to a 2% acquisition tax based on the assessed value of the property.
  4. Mexican property tax (predial) is payable annually. On average, it is0.1% of the assessed value of the property at the time of sale.
  5. The MLS Vallarta website has a number of useful articles on real estate transactions.
  6. Click here for a useful slideshow overview on taxes in Mexico, prepared by Puerto Vallarta attorney, Claudia Cardena.

[1] Under the Mexican Constitution of 1917, land in Mexico could only be owned communally (ejido) or by Mexican citizens. The 1973 “Law to Promote Mexican Investment and to Regulate Foreign Investment” amended the Mexican Constitution to permit non-Mexicans to own real estate anywhere in the country except the restricted zone, and to own real estate in the restricted zone through fideicomisos. (The restricted zone runs 100 kilometers from Mexico’s international borders and 50 kilometers inland from the Mexican coastline, so all oceanfront property is within the restricted zone.) These constitutional amendments reflect the very friendly view taken in Mexico toward foreign investment and ownership. The fideicomiso is a time-tested method of beneficial ownership that is just as reliable as fee simple title in the US.
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[3] In the more typical foreign trust (such as a Cayman Island or Isle of Man offshore trust), the beneficiary receives annual distributions, which the IRS tries to tax and the beneficiary seeks to shelter. Fideicomisos are nothing like that. In a fideicomiso, the beneficiary receives no distributions (except when the property is sold), and there is no issue over whether income is taxable. Conceptually and in practice, fideicomisos are quite different from the typical foreign trust. Nevertheless, the IRS treats fideicomisos as foreign trusts, and imposes the same reporting requirements on the beneficiaries of fideicomsos as any other foreign trust. There is some debate as to whether fideicomisos should even be included in the Section 6048 definition of foreign trusts. Until the issue is resolved, the safer course—especially since it isn’t difficult or expensive—is to file Forms 3520 and 3520-A.

Incidentally, unless your tax preparer has an international practice, he or she may not be familiar with the forms used to comply with Section 6048. The forms are available for free online, and the IRS instructions walk you through the requirements.

  1. Form 3520 - Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
  2. Department of the Treasury, Internal Revenue Service, Instructions for Form 3520
  3. Form 3520-A - Annual Information Return of Foreign Trust With a U.S. Owner
  4. Department of the Treasury, Internal Revenue Service, Instructions for Form 3520-A

To print or download go to: http://www.irs.gov/formspubs/lists/0,,id=97817,00.html
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[4] Section 280A(d) of the Internal Revenue Code provides:

(d) Use as residence.

(1) In general. For purposes of this section, a taxpayer uses a dwelling unit during the taxable year as a residence if he uses such unit (or portion thereof) for personal purposes for a number of days which exceeds the greater of—

(A) 14 days, or

(B) 10 percent of the number of days during such year for which such unit is rented at a fair rental.
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[5] The full name of the tax treaty is the Convention between the Government of the United States of America and the Government of the United Mexican States for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed September 18, 1992. Copies are available online at http://www.abanet.org/intlaw/committees/tax_estate_individuals/tax/mexico.pdf

An IRS publication explaining the Convention is available at http://www.irs.gov/pub/irs-utl/mexicotrweb.pdf
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