Capital gains tax law in Mexico states that tax is owed on the profit you receive when you sell your home or property.
For a foreigner purchasing property in Mexico who is a non-tax resident of Mexico, the capital gains tax deductions allowed are:
- Inflationary credit: Applied for each year of property ownership. Depreciation of construction and then the inflationary credit is applied.
- The Acquisition tax paid with the corresponding factura, from your purchase price, 2%
- Real Estate commissions to sell the property with the corresponding factura and IVA tax paid
- Notary Fees with the corresponding factura
- Public Registry fees with the corresponding factura
- Deductions allowed for capital improvements: You can deduct the costs of any capital improvements IE: building extensions, new flooring, swimming pools, new rooms, while you owned the property but you need facturas for all services and building work to claim these allowances when you sell, be sure to talk to your Notary Public on how to account for these and FOLLOW IT or else you may not be able to deduct them on a future sale. Any capital improvements made using a firm or builder and you did not get facturas, these works cannot be deducted. General maintenance and home improvements like remodelled kitchens and bathrooms do not count as capital improvements, nor do moveable items like furniture, draperies, TV, BBQ, lamps etc.
As a non-tax resident, your options for capital gains tax calculations are:
- You pay 35% of the net profit. There are a variety of deductions included in this option, and usually is the best calculation to provide you with the lowest amount of tax to pay. This option typically is the better option that will give you a higher net from the sale of the property.
- You pay 25% of the “selling price” no deductions
The capital gains tax calculation is done in pesos based on the exchange rate when you purchased and the exchange rate when your sale closes, to determine the gain on the sale of the property. It is never calculated in US dollars.
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 sell.
*Percentages reflect the 2020 tax code
A Mexican Individual or Resident of Mexico:
The allowable deductions are the same as for the non-tax resident. But the tax for selling varies based on their income and ranges from 2% to 35% for the percentage taxed on capital gains tax. In their annual tax return, there may be an adjustment based on all income during the year.
A Mexican Company:
May acquire property and there is no capital gain. When the company sells its properties, it is withheld by the Notary as the Mexican Company and is taxed based on the overall of its income versus all of its expenses. The Mexican Company may acquire a property and may sell it but if it has losses for other activities then they are offset. Living expenses are not deductible unless they are needed to generate the income. The deductions are done monthly through accounting with expenses vs income and then the Mexican Companies annual tax returns. Depreciation also applies.
Note* Setting up a Mexican Company / Corporation is not a way to avoid capital gains taxes and it is not for owning residential properties.
Property ownership through an LLC or foreign corporation:
An entity can be placed as the owner of the property through a Mexican Escritura and through a Fideicomiso. Note that some years ago most trust banks allowed entities as the primary beneficiary of the trust but in Los Cabos, currently only one trust bank department allows this, no other trust departments do. By placing an entity as the owner or primary beneficiary does not mean you will not have capital gains tax. Any changes internally to the LLC or Corporation, Living Trust or entity will trigger capital gains tax in Mexico. And the same percentage of capital gains tax and deductions apply regarding of the ownership by a foreign entity.
ALWAYS RECORD YOUR TRUE PURCHASE PRICE AT CLOSING
In the past, some real estate companies have recommended recorded values lower than the actual purchase price in an effort to “save” taxes for their client; they thought they could save money on the two percent acquisition tax. This is a major error. Never record a lower value than what you actually paid for the property. Doing so simply establishes a lower-cost basis for the property, which increases your capital gains tax liability. The first step in calculating your capital gains is to subtract the value you have recorded in your trust/Fideicomiso from the sale price of your property, but this is done in pesos at the exchange rate of the original purchase and the current sale price
An oversimplified example is: You wisely purchase a property for $1 million USD, but unwisely record a value of $500,000 USD. In the eyes of Mexican tax law, your cost basis is now $500,000. If you sell the property for $1.2 million, you see a profit of $200,000 trading dollar for dollar. However, according to your recorded cost basis, Mexico sees a profit of $700,000. Recording your authentic purchase price with proper documentation is the only way to maximize your potential profits. The bottom line is to always secure your property trust for the true value of your purchase.
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. Recording a lower value today can cost you, should you decide to sell in the coming years. If a Seller can convince a Purchaser to record a lower value, the tax liability is simply passed along, and eventually, someone will have to pay. Don’t let anyone tell you, “That’s how we do it here.” Mexico is like everywhere else — the capital gains tax is the responsibility of the Seller.
FACT: Recording a property’s true value benefits you and establishes your cost basis in the eyes of Mexico.
FACT: The amount you pay for a property has no impact on your yearly property taxes.
FACT: Capital gains taxes you pay in Mexico can be applied to your U.S. or Canadian taxes as a tax credit. Be sure to talk to your accountant. You might have tax to pay tax in your home country depending on how your accountant claims your foreign property, expenses etc on your income tax return.
HOW DO I KNOW IF MY VALUE IS RECORDED PROPERLY?
You can verify the value yourself by examining your trust and noting the amount written in text, which is indicated in U.S. dollars and or Mexican pesos and includes the exchange rate of that day. Simply divide the current exchange rate into the peso amount and make sure the result reflects the actual dollar amount you have paid.
WHAT IS AN INFLATIONARY CREDIT?
As soon as you pay your two percent acquisition tax to receive your trust, you are eligible to receive an inflationary credit from the Mexican government for each year you own the property. This credit is added to your cost basis when you decide to sell your property. The credit is based on consumer index adjustments (inflation) and can be quite significant. The inflationary credit is calculated depending on each year of property ownership, in addition; there is a 3% depreciation for the construction and that reduces your tax base. The norm is 20% for the land value and 80% for the construction. Land does not depreciate.
Fact: You are not eligible to receive the inflationary credit unless you have paid your two percent acquisition tax.
WHAT ABOUT THE PRIMARY RESIDENCE OR CAPITAL GAINS TAX EXCLUSION?
One time tax allowance exemption is available under Article 92 Fraction XIX a of Mexican income tax law that reduces the tax liability for family (primary residence) homes although you and the property must meet criteria to qualify for the exemption:
- You must be a resident of Mexico with a tax ID RFC, Registro Federal Contribuyentes
- The property your selling IS your primary residence, you are only allowed one worldwide and must prove you are living there full time
- The land subject to the sale must not exceed three times the size of the construction on that land measured in square meters
- You can only claim this exemption once every five years
The flat rate exemption is the peso equivalent of 700,000 UDIs, the value of the UDIs fluctuates and you can get current UDI exchange rates on the Bank of Mexico website. If the same home is properly co-titled with your spouse or other family member and they are a resident of Mexico, with a Mexican tax ID, RFC and the house is their primary residence too you can deduct an additional 700,000 UDIs in their name.
The tax-deductible allowance is not automatic: you must qualify and you must prove the qualification. Talk with your Notary Public and or closing attorney about how to arrange this and what you need to do to present the necessary records for proof.
*Mexican income tax law does not expressly state whether the foreign person selling a property must have temporary or permanent residency status to avail themselves of capital gains tax exemptions; it does, however, expressly state that the seller must be selling his/her primary residence in order to qualify for tax exemptions. The Notary dealing with the matter will interpret the law; some will apply the CGTax exemption only if the seller has residente permanente; some Notary Public offices may apply the exemptions to foreign residents with residente temporal status.
Mexico, as well as the U.S., provides its residents with a capital gains tax incentive for their primary home. 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 was your primary residence for a period of five years. At closing, you will be required to provide the Notary proof of your Mexican citizenship (or in the case of foreigner your permanent residence visa) as well as a bank account, water, phone and electric bills, all in your name and reflective of full time usage for services, paid tax receipts and your Trust or Escritura — all in your name, all with the address of the home, and all in place for more than five years. You will need an RFC, tax ID number and CURP. You will also need from the federal tax office (SAT) Constancia de Situacion Fiscal. You also may need proof of income within Mexico. Please keep in mind that this is just a guideline of the requirements. It is necessary to communicate with the Notary prior to closing your transaction in order to know if you are eligible for exemptions. Don’t wait until the closing to determine if you are exempt or not. The calculation is not made by a simple 100% exemption status.
FACT: A foreign full-time permanent resident with a permanent resident visa in place for 5 years and their home in Mexico as their primary residence has the right to be exempt from $700,000 UDIS
The seller “must be” immigrated and fulfilling the requirements as Mexican Tax ID etc. and obtains only a partial exemption.
The UDI is the Financial Mexican Index with a current value (October 2019) $6.301316 Pesos
$700,000 x $6.301316 = $4,410.921 pesos (approximately $240,000 exchange rate October 2019)
This is the maximum amount that a seller can be exempt from the said tax.
EXAMPLE: property selling price $415,000 USD
The seller shall pay capital gains tax on the difference $415,000 – $240,000 = $175,000
The preliminary calculation takes into consideration the following deductions:
*$700,000 UDI
*Real Estate Commission
*Acquistion tax from the time seller purchased the property.
*There may also be an additional inflationary credit applied for each year of property ownership.
For a complete evaluation of your tax exemption status, you should have a consultation with a Notary prior to listing and selling your property.
FACT: You cannot have two primary residences at the same time. Therefore, if you claim the home in Mexico as your primary residence, you give up your primary residency status in your other country.
FACT: The capital gains tax exclusion is not for persons owning second homes or vacation homes.
Just as there are no shortcuts or legal ways around taxes in the U.S. or Canada, there are no shortcuts around taxes in Mexico. Your home is a sizable investment and following proper legal steps will ensure a safe and enjoyable experience in Mexico.
If someone says, “This is Mexico, and that’s the way we do it here,” then beware. Seek another agent or Broker. If you plan on building a home or doing a major remodel to an existing home, you should inquire about properly Manifesting Your Construction to make certain all your expenses are added to your cost basis. If you are considering a real estate purchase in Baja, make certain everything is done right.
HELPFUL HINT: Your purchase price will be recorded in USD and the exchange rate of the day in pesos. If you closed and the exchange was not recorded a historical chart can provide the exchange on the day your trust was registered. Every Closed sale document package includes an ISABI, A Declaracion Para El Impuesto Sobre Adquisicion de Bienes Muebles. This document will have your recorded pesos value and is used for the capital gains tax calculations.
There are many more aspects to capital gains taxes in Mexico. This article is to simply inform you, not to interpret the laws. Always check with your notary before you sell. Don’t wait until you are at the closing table to find out about your capital gains tax obligations.
NOTE THAT TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE
