Protect your investment. Record the cost of your new construction. Receipts alone won’t cut it.
The following is an overview regarding the manifestation regulations currently in place for individuals. Please note that the information is intended for individuals, not corporations. Over time these regulations may change, therefore it is important to make sure that the process outlined here is still in effect by contacting a certified accountant or Mexican Notario or perhaps there are new regulations and laws in place.
Q. What is manifesting?
Manifesting is simply recording the amount of money spent on a home’s construction or remodel, in order to add it to the Owners’ cost basis. Adding to your cost basis is the key to reducing your capital gains tax. Proper documentation and manifesting your construction are vital to building your new home.
Q. Why do I need to manifest my construction?
When you sell your home, the manifested cost plus the cost of your lot stated in your trust (title), will be used to determine the basis for capital gains tax. If you have not manifested your construction, Mexican tax law will not recognize your construction costs and you will not be able to use them as a deductible expense. All of your receipts, cancelled checks and bank statements will not help unless you have completed your manifestation. Before you begin construction, decide how to structure your financial arrangements with your contractor. The two main choices are Cost Plus and a Fixed Bid.
Q. What is a cost plus contract?
With a Cost Plus contract, the Owner pays the contractor for the cost of materials, plus a fee or a percentage for labour. Using this method, it is necessary to keep excellent records in order to prove all expenses. Each time you pay the contractor, he must provide you with a legal Mexican invoice called a “factura.” Each factura must be in the name of the Primary Beneficiary named in the trust /title and will include sales tax called IVA. Without facturas, nothing you spend is deductible as an expense in Mexico. Also, with Cost Plus, you (not the contractor) are responsible for paying the Social Security tax for each person working on your home.
Q. What is a fixed bid contract?
With a Fixed Bid contract, the contractor quotes you a flat fee to build your home. A fixed bid includes all labor, materials, Social Security, etc. It is all-inclusive. When using the Fixed Bid process, the burden of record keeping is on the contractor, and you do not have to pay the IVA sales tax each time you make a payment. It is, however, still necessary to receive a factura (Mexican invoice) from the contractor for each payment. The factura should reflect the amount of the payment due sans the IVA sales tax. Mexican tax law states there is no IVA for the construction of a personal residence provided the contractor is providing an all-inclusive bid. Again, the Fixed Bid process is much less labor-intensive for you and puts the majority of the record keeping burden on the contractor.
Q. How do I pull a building permit?
The building permit is the first step to manifesting your property correctly. You will need the permit both to start construction and finish construction. The permit is pulled from the “Departamento de Obras Publicas,” the government Public Works office. Normally, the contractor will pull this permit. Be advised that there are two things you need to watch for:
- Make sure the building permit is pulled in the same name as the Primary Beneficiary named in your trust/title.
- Make sure the building permit represents the approximate and higher amount of the construction the contractor has quoted.
The fee for the building permit is based on the estimated value of your construction. In an effort to reduce this fee, some contractors will report a lower construction amount when pulling the permit. This is a huge mistake. You want your construction costs recorded accurately so that your cost basis will be accurate for capital gains.
Hint: When using Fixed Bid, make certain the contractor is in agreement to provide you with a factura with no IVA sales tax added for each payment. Remember to have this in writing in your construction contract.
Hint: Never report a lower construction value to save some money on the permit fee — it will cost you much more in the long run.
Q. What is a letter of termination of works and why is it necessary? LETTER OF TERMINATION OF WORKS
When construction is finished and you are ready to manifest your construction, you will need to take your building permit to the Departamento de Obras Publicas (Public Works) with a letter stating the total amount you spent on your construction and confirmation that construction is finished. You or your contractor can write the letter. With this letter, you will request an official statement of completion called an “aviso de terminación de obra,” which is a “Letter of Termination of Works.” This letter will state the amount you spent on your construction, which should be in accordance with the amount stated on the building permit.
The Letter of Termination of Works is the document that actually establishes your construction cost basis for the tax office.
Q . What is Mexican Social Security?
Social Security is a very serious issue in Mexico. Your home can actually jave a lien placed on it or sold to force payment if social security taxes are not paid. Beware, this can happen even years after you finish your construction. If the amount of Social Security taxes paid corresponds to the amount of your construction, you will receive a letter from Social Security called “Carta de Razonabilidad de Pago,” which means “Letter of Reasonability of Payment.” This letter is very important, as it is your protection to prevent any future claims for non-payment of Social Security taxes. Before you can receive your Letter of Termination of Works, you will be required to have this letter from Social Security
Manifesting Your Construction, for Good.
Once you have your Letter of Termination of Works and your letter from Social Security, you simply take them to the tax office (Oficina de Catastro). There, the value will be recorded and added 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.
Fact: If you do not have a trust, you should not begin construction. Without the trust document you cannot pull a building permit in your name and you run the risk of not being allowed to deduct your land cost or construction cost when you sell.
Fact: Annual property taxes are relatively low in Mexico, but capital gains taxes are not. Registering an inaccurately low number will cost you much more in the long run. 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 costly 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.
Always get your trust.
Always record the real value of your purchase.
Always purchase U.S. Title Insurance.
Always manifest your construction.
If you are considering a real estate purchase in Baja, make certain everything is done correctly.
