What Is "Manifesting" And Why Do I Need It?

Manifesting is simply recording the amount you spend on your construction or remodel in order to add this to your cost basis. Adding to your cost basis is the key to reducing your Capital Gains Tax. Proper documentation and manifesting your construction is a vital part of building your home in Mexico.

The manifested cost plus the cost of your lot (stated in your Trust), will be used to determine the basis for your Capital Gains Tax liability when your home is sold.

If you have not manifested your construction, Mexican Tax Law will not recognize your construction costs and you will not be able to use the expenses as a deduction. All your receipts, cancelled checks and bank statements will not help unless you have completed your manifestation. Here’s how to do it.

BEFORE YOU BEGIN CONSTRUCTION

Decide how to structure your financial arrangements with your contractor. Your choices are as follows:

COST PLUS

With Cost Plus, you pay the contractor for the cost of materials, plus a fee of 12-20%. Using this method, you will need to keep excellent records in order to prove all your expenses. With this method, you are responsible for paying Social Security tax for every person working on your home…your contractor is not responsible. Each time you pay the contractor, he must provide you with a legal Mexican invoice called a Factura. Each Factura must be in your name and will include a 10% sales tax (IVA). Without these Facturas, nothing you spend is deductible as an expense in Mexico.

FIXED BID

With a fixed bid contract, the contractor quotes you a flat fee to build your home. It is all inclusive and will include labor, materials, & Social Security. When using this method, you put the burden of record keeping on the contractor and you do not have to pay the 10% Mexican IVA tax each time you make a payment. You’ll still need to receive a Mexican invoice (Factura) from the contractor for each payment to him. The Factura should reflect the amount of the payment due with no 10% sales tax (IVA). As you can see, the Fixed Bid process is much less labor-intensive for you.

TIP: IVA tax is a sales tax and Mexican Tax Law states there is no IVA Tax for the construction of a personal residence, provided the contractor is using the Fixed Bid concept.

TIP: When using fixed bid, make certain the contractor agrees to provide a Factura for each payment with no IVA tax added. Have this written into your construction contract.

BUILDING PERMIT

The building permit is the first step to Manifesting your property correctly. You will need the permit to start and to finish construction. The permit is pulled from the government office (Obras Publicas-Public Works) The contractor will pull this permit for you but you must be aware of the following:

The permit must be in the same name as the Beneficiary named in your Trust. (Feideicomiso). The building permit must represent the approximate amount of the construction costs that has been proposed by the contractor.

The fee for the Building Permit is based on the estimated value of your construction. Some contractors, in an effort to reduce the cost of the Permit, will report a lower construction amount. This is a big mistake! You will want your construction costs recorded accurately so your cost basis will reflect the proper amount for your Capital Gains Tax.

LETTER OF TERMINATION OF WORKS

When construction is completed, you are ready to Manifest your Construction. You will need to take your Building Permit to the Obras Publicas office along with a letter stating the amount you spent and that you have completed the construction. This can be done by you or your contractor. With this letter, you will be requesting an official statement of completion (Adviso de Terminacion de Obra or Letter of Termination of Works).

This letter will state the costs of your construction and should be in accordance with the amount stated on the Building Permit. THIS LETTER IS THE DOCUMENT THAT ACTUALLY ESTABLISHES YOUR CONSTRUCTION COST BASIS FOR THE TAX OFFICE.

SOCIAL SECURITY

Social Security is a very serious issue in Mexico and a lien may be put on your home or sold to force payment if these taxes are not paid. This can actually happen after construction.

When you receive your “Letter of Termination of Works”, Obras Publicas will send a copy to the Social Security office. They will compare this amount with what you or your contractor has paid to Social Security during construction. If you are using the Cost Plus method, you are responsible for paying the taxes and if the Fixed Bid method is used, the contractor is responsible for these taxes.

If the amount of Social Security Taxes paid is verified correctly, you will receive a letter from Social Security called a “Carta de Razonabilidad de Pago” . (Letter of Reasonability of Payment). This is a very important letter and is your protection against any future claims for non-payment of Social Security taxes.

Once you have your “Letter of Termination of Works” and the letter from Social Security, you must go to the tax office (Catastro Office) where they will record the value and add it to the cost reflected on your Trust document. Once completed, you have successfully Manifested your Construction and established an accurate tax basis for your property.

TIP: If you do not have a Trust, you should not begin construction. Without a Trust document, you cannot pull a building permit in your name and will run the risk of not being allowed to deduct your land or construction cost when you sell.

TIP: Annual property taxes are relatively low in Mexico…capital gains taxes are not.

This article is an overview of the Manifestation regulations currently in place for individuals. The information is intended for individuals, not corporations. Over time, these regulations can change so it is important to make sure the process outlined here is still in effect by contacting a certified accountant or Mexican Notario.