Capital Gains In Mexico

Understanding the Tax Laws in Mexico is an extremely important part of the Purchase Process. What you do today dictates your tax liabilities tomorrow.

The information provided here is to help you understand the tax system in Mexico and the important issues related to them. We highly recommend that you meet with a tax professional prior to completing your purchase to confirm if any of the laws have changed since this document was published in 2003.

Capital Gains Tax Law in Mexico states that tax is owed on the profit you receive when you sell your home or property. By law, you have two options when it comes to capital gains.

Option 1 35% of the net profit. There are a variety of deductions included in this option. Or

Option 2 25% of the gross amount with no deductions.

These percentages reflect the 2003 tax code

Although a 35% Capital Gains Tax may seem high, Mexico does have several laws and procedures that will assist you in maximizing your cost basis, thereby reducing your net profit and lowering your Capital Gains. The key is to understand these laws before you buy, not when you decide to sell. The Notario is the only person authorized to make the calculation and collect the taxes for payment to the authorities. The tax is commonly referred as I.S.R. and the Notario is personally liable if he does not collect the correct amount.

WHY SHOULD YOU TAKE ON THE SELLER’S CAPITAL GAINS LIABILITY?

The first step in calculating your Capital Gains is to subtract the value you have recorded in your Trust (Feideicomiso), from the sales price of your property. In the past, some real estate companies recorded values lower that the actual purchase price in an effort to “save” money for their client. Their thinking was to save money on the 2% acquisition tax. This should not be done. Never record a lower value than what you actually paid for the property. Doing so establishes a lower cost basis for the property which eventually increases your Capital Gains Tax liability.

A simple example is: You purchase a home for $1,000,000 (your dream home!) but record a value of $500,000. Mexican Law says your cost basis is now $500,000. However, if you sell the home for $1,200,000, you realize a profit of $200,000 but according to the recorded cost basis, Mexico sees a profit of $700,000. Your Capital Gains Tax in Mexico would be 35% of $700,000 or $245,000. You just lost $45,000 instead of making a profit. Therefore: ALWAYS RECORD THE FULL VALUE OF YOUR PURCHASE.

Ownership in Mexico, specifically the Trust process, has been established to protect you and provide you with the legal means to safeguard your investment. Recording your real purchase price and proper documentation is the only way to maximize your potential profits. Never allow anyone to convince you to record a lower value than what you have actually paid for your property, or YOU will assume the seller’s Capital Gains Tax liability. If a seller can convince a buyer to record a lower value, the tax liability is simply passed along, and eventually someone will have to pay. Mexico is like anyplace else. The seller assumes the responsibility of the Capital Gains Tax. Resist the idea of under reporting the purchase price to lower your yearly property tax. Besides being illegal, when you go to sell the property, the tax liability will be yours.

TIPS : The amount you pay for a property has no impact on your yearly property taxes and remember the Capital Gains Tax you pay in Mexico can be applied to your U.S. taxes.

WHAT IS AN INFLATIONARY CREDIT?

As soon as you pay your 2% Acquisition Tax to receive your Trust, you are eligible to receive an inflationary credit from the Mexican Government for every year you own your property. This credit is added to your cost basis when you decide to sell your property.

The credit is based on the Consumer Index (inflation) and can be quite significant. There have been credits in excess of 20% per year applied to a cost basis. On a million dollar property, this can be as much as $20,000 per year added to your cost basis and significantly reducing your Capital Gains Tax should you decide to sell later.

TIPS: You can receive the inflationary credit based on the date of your buy/sell agreement however, you are not eligible to receive the inflationary credit unless you first pay the 2% Acquisition Tax.

TWO-YEAR CAPITAL GAINS EXCLUSION

Mexico, as well as the U.S., provides its residents with a Capital Gains Tax Incentive for their primary home. The Tax Incentive in Mexico states that if you sell your “primary residence” after two years, you pay no Capital Gains. This law is in place for “Residents” (Mexican Nationals or Foreigners) of Mexico only, and there are several items required to establish residency status. In order to claim your home as your primary residence in Mexico, you must be able to prove that it really is your “primary residence”.

At the closing, you will be required to provide the Notary with a resident visa or working permit (FM2 or FM3) as well as a bank account, water, phone and electric bills, paid tax receipts and your Trust . These must be in your name and with the address of the home that you have lived in for the past 2 years.

TIPS: You cannot have two primary residences at the same time and the Capital Gains Tax Exclusion is intended for residents of Mexico, not for persons owning second homes or vacation homes.