Everyone involved in real estate has heard the adage “Location, Location, Location.” While undoubtedly this saying has a lot of truth to it, no less true is the following: “Taxes, Taxes, Taxes.” When two countries can claim tax jurisdiction over you and your income, things can become complicated. Today we’ll examine these issues from the Mexican perspective, especially as they relate in real estate. I originally wrote a version of this article in 2005 called “Taxes Here, Taxes There, Taxes Everywhere”. Amazingly, it still comes up in web searches! The time has come to update it to reflect the many changes that have happened over the last 15 years!
Tax residence and legal residence are not the same. Countries have different rules to decide who is a tax resident and separately, who has status to remain in the country legally. Some countries have entered mutual tax conventions that further define and clarify who is considered a tax resident. This is important because tax residents and non-tax residents are treated differently.
Article 4 of the U.S. Mexico Tax Conventions states that you are a tax resident in the country where you have established your abode. That is right, you are a tax resident of Mexico on day one when you establish a home in-country.
If you have a permanent home available in both countries, you will be considered a tax resident of the country where you have your center of vital interests. In the case of Mexico, your center of vital interests is defined as being in the country where you work or from where you derive over 50% of your income.
Tax residents of Mexico are required to report worldwide income on their Mexican tax returns. Any income, formulas, exemptions, taxes rates, etc. are all different than what you find in the U.S. Therefore, all your U.S. economic activity is subject to reporting, including that in qualified accounts, and Mexican tax paid accordingly.
Non-tax residents only pay Mexican income tax on Mexican source income.
U.S Citizens and residents are required to file and pay U.S. income taxes to the U.S., on the same worldwide income. Fortunately, any income tax paid in Mexico is likely to generate U.S. tax credits which could reduce any tax paid in the U.S.
Note that no mention is made of legal residence here. You could be living in Mexico as a tourist, have obtained your Permanente, be living in the country as a dual national, or even have no legal papers, and still be a tax resident. Legal status should not have a bearing on tax residence, although some Notarios will require proof of both legal and tax residence before granting certain tax benefits. This is incorrect in my opinion.
Rental income generated in Mexico is subject to Mexican income taxes. Gross rental income is reduced by certain allowable deductions and marginal income tax is paid on the net income. Unlike the U.S., depreciation is not an allowable deduction. Note that any rental income derived from property in the U.S. owed by a Mexican tax resident is also subject to income tax in Mexico.
As an alternative to actual expenses, you are allowed to reduce gross income by 35% if that will result in a larger than actual allowable expenses.
Certain rental activity is also subject to value added taxes (see below).
Capital Gains Taxes
The sale of property (including securities) is subject to capital gains taxes. When property changes hands and capital gains taxes are due, the agent facilitating the transaction is often required to withhold a percentage of the proceeds. In real estate transactions in Mexico the Notario prepares the capital gains calculation and withholds income as appropriate.
How capital gains are calculated on the sale of property in Mexico involves a lengthy calculation that I will spare you. However, like in the U.S., there is a cost basis which is adjusted. Improvements and additions to the property increase cost basis and must be proven with official receipts, called facturas. Make sure you keep these official receipts in your files. Unlike in the U.S., the cost basis is adjusted up according to official inflation numbers.
For tax residents, there is an exemption on capital gains if the property that is being sold has been used as your principal residence. The exemption currently applies up to 700,000 UDIs (an inflation adjusted alternate measure of value in Mexico) currently equivalent to about $225,000 (USD), per person. Gains above this exempted amount will cause the Notario to withhold, and such income will incur income tax at marginal rates as high as 35%. You can only use the exemption once every three years.
Non-residents cannot get a capital gains exemption on the sale of a home in Mexico and generally pay tax on any gain at Mexican resident marginal tax rates, up to 35% of the gain.
Rental property is not exempt from capital gains when sold.
Changes in the exemption amount occur often, so be sure to check with your Notario what the current law says in this regard before you sign a sales agreement!
Property sold in the U.S. is also subject to be reported in Mexico if you are a tax resident.
Value Added Tax
Like in many countries of the world, Mexico has a value added tax, or Impuesto al Valor Agregado (IVA). As far as the consumer is concerned, IVA feels like a sales tax. The tax is added to the cost of most goods, as well as services, sold in Mexico. At present IVA is 16% in most of the country with a subsidized rate of 8% on the U.S. border. Some goods and services do not generate the tax, including certain foods, medicines, books, doctors’ bills, and tuition.
If you are renting out property for non-business use, you will not be required to collect IVA on the rental income, as long as the property is unfurnished. Furnished homes and other property rented for business use are subject to IVA.
Properties that are used for short-term rentals are almost always furnished and are considered businesses in any case. This type of activity is subject to IVA. In fact, per recent regulations, listing sites, such as Airbnb, will be required to collect IVA (as well as occupancy taxes) on behalf of the property owners.
Several jurisdictions in Mexico charge occupancy taxes on hotel and Airbnb type of arrangements. These range between 3% and 5%.
Estate and Inheritance Taxes
At present, Mexico does not have either an estate tax or an inheritance tax applicable to tax residents. However, in 2018 a proposal was made to Congress to institute such a tax and unify it with a proposed new gift tax (see below). As presented, the first MX$10 million would be exempt from tax and thereafter marginal tax rates of 10%, 20% and 30% would apply. Apparently, there is no current interest to enact the proposal at this time.
Note that non-tax residents are subject to a tax on any gratuitous transfer at a rate of 25%. Property received via inheritance or gift is a gratuitous transfer.
Gifts between tax resident spouses and direct family members are not taxable. Thus, under current law, if you are a tax resident and want to gift a $500,000 (USD) home to your daughter, there would be no gift tax imposed in Mexico. Note, per the comment above, there is a proposal in Congress to implement a unified gift and estate tax at some point in the future.
In Mexico, property taxes are called predial. Compared to property taxes in the U.S., the cost of the predial is incredibly low. Predial is a local tax and being local different jurisdiction have different ways of letting people know what the tax bill is. The more sophisticated jurisdictions might send you a bill via snail mail or to an email address. In other jurisdictions you need to present yourself in person at the local tax assessor’s office to request the bill.
The tax is applied on the tax assessment, or valor catastral, that is prepared by the municipal authority. Different states have authorized different mill rates for their municipalities. The funds are usually used to fund local projects.
In many parts of the country, payments made in full and on a timely basis may result in a significant discount.
In my experience, local governments will not foreclose on properties that are delinquent on the tax bills. However, it will not be possible to transfer the property in the future if the bills and possible penalties and interest, are not paid in full. Depending on the jurisdiction, unpaid bills might be negotiated down.
It is important to remember to keep close track of the paid tax bills. You will need to show the paid receipts when the property in question is sold, or otherwise changes hands.
When acquiring property, by purchase, gift, inheritance, or otherwise, there are several taxes and fees that you should be aware of. Principal among these is the acquisition tax. In some jurisdictions the tax is a percentage of the declared value, in others a flat fee, so that there is wide variation, state to state. There are other fees related to the purchase of real estate, such as registration fees, closing costs, title search and insurance (recommended but not required). Make sure you get a quote as part of your due diligence.
I have given a quick review of the “taxes, taxes, taxes” that a person is likely to encounter in Mexico, especially as related to real estate. The main takeaways are as follows:
- Mexico taxes residents and non-residents differently.
- Mexico taxes income tax residents on worldwide income
- Mexican taxes are calculated differently than in the U.S.
- Rental and capital gain income are subject to income tax.
- Listing agents are being required to withhold income.
- At present, there is no gift or estate tax applied to tax residents.
Another big takeaway is that it is best to avoid becoming a Mexican tax resident in the first place. You may lose the ability to sell your home and get a capital gains exemption, but you will not be subject to Mexican income tax on worldwide income. As always, please consult with a qualified financial planner or other professional with appropriate international experience.
Given the volume of inquiries I have received in the past, and the inability to provide proper advice without gathering a significant amount of information, I will generally not be available to answer personal questions unless we sign an engagement letter. Pinnacle Advisory Group is a U.S. registered investment advisor (RIA) providing comprehensive financial planning since 1998. We get paid in two ways: preparation of comprehensive financial plans and by managing the investment portfolios according to one of our unique models. Our minimum required investment for international clients is US$1 million (USD), but exceptions can be made case by case If you are interested in our valuable services, please explore our website, and feel free to make an appointment with me by accessing my personal calendar here, or click on the calendar icon below. I would be happy to explore how we can work together!