Capital Gains Tax (ISR) On The Sale Of Homes In Mexico

 

This is a subject that everyone wants to know about and, everyone wants to find a way to legally avoid. In an effort to keep you up to date, the following is the “brief” version of what you need to understand. 

First of all off we must clarify some very important definition's used under tax law. Without fully understanding these definition, we will be lost when talking about taxes.

“SALE”.- For tax purposes a sale of real property occurs when there is:

a) A transfer of property, even those in which the seller reserves the ownership of the property sold.
b) A transfer of trust (fideicomiso) rights, changing the beneficial rights of the trust.

“ MEXICAN FISCAL RESIDENCE”.- Individuals are considered fiscal residents of Mexico, when they have a dwelling in Mexico. Those who also have a dwelling in another country will be considered Mexican residents if the “center of their vital interests” is located in Mexican territory. NOTE.– A FISCAL RESIDENT OF MEXICO MUST ALSO BE A REGISTERED TAX PAYER AND FILE ON “WORLD WIDE INCOME” IN MEXICO

“CENTER OF VITAL INTEREST”.- You will be considered to have your center of vital interests in Mexico when:

a) The source of wealth of more than 50% of the total income obtained by the individual in the calendar year is in Mexico.
b) The individual's center of professional activities is located in Mexico.

“DWELLING”.- It is a house for home purposes, except when house is used for temporally tourist activity.

I will ask everyone to re-read the definition of “Fiscal Resident” because there are two sets of rules and one applies to “Fiscal Residents” and the other applies to everyone else. If you are not a “Mexican Fiscal Resident” you will NOT get the exemption benefits given under the law.


EXEMPTIONS ON THE SALE OF A HOME FOR “FISCAL RESIDENTS”


Exemptions for “Fiscal Residents”, which apply to the sale of one home every 5 years.

Case 1.- When sales price is lower than USD$500,000

When the amount of the sale does not exceed million five hundred thousand investment units (approx: $519,000 USD), the sale is exempt of Income Tax if you are a “Mexican Fiscal Resident”.

Case 2.- When sales price is higher than USD $519,000

If you are a “Mexican Fiscal Resident”, when the amount of the sale exceeds $519,000 USD you will pay tax on the amount that exceeds such amount “proportional to the amount that results from dividing the amount that exceeds by the total amount of the sale”. What????? Let’s look at an example:

Purchase price $ 300,000 dollars, when you bought our property.
Sales price $ 1,000,000 dollars

Income Tax Calculation:

  Sales Price $1,000,000  
(-) Income exempt 519,000  
(=) Taxable income (Which represents 48% over purchase price)   $4810,000
  Total Cost $300,000  
(*) % deductible 48%  
(=) Deduction allowed   144,000
  Capital Gain over which tax will be calculated.   $337,000

 

 

 

 

 


B. House sale if you are a “Fiscal Resident” for more than 5 years of a home. Sale of the home is full exempt.

WHO CALCULATES INCOME TAX, HOW YOU PAY IT AND WHAT DOCUMENTS ASK FOR TO PROVE “FISCAL RESIDENCE”.

NOTES:

1.- Exemptions only apply to construction and on land only “up to 3 times the area covered by the construction.” In order to do this calculation the value of the construction and land need to be separated if the land area is over 3 times the “foot print” of the construction.
2.- Even though you are exempt from this tax, you must declare income on your Mexican annual filing for any residential sale that is over.

3.– Exemptions can only now be taken ONCE EVERY 5 YEARS. Prior to 2010 it was once every year.

The notary is the person responsible for calculating, withholding and paying income tax on the sale of home that belongs to individuals (not corporate entities). In our experience most notaries have “tax advisors” who assist them with the calculation of taxes. We strongly advise that you get an independent advisor to do your own calculation of this tax. While notaries have very competent advisors, other experienced counsel can sometimes save you tens of thousands of dollars in taxes vs. the calculations given by the advisors of notaries.

In order to prove “Fiscal Residence” you will have to confirm before the public notary that the property in question is your residence with any of the following documents:

I. Voter ID, issued by the Electoral Federal Institute of Mexico (Mexican Nationals only) or FM3/FM2 for foreigners.
II. Electrical or telephone bill from the home.
III. A recognized bank or investment fund statement addressed to the home.

Note.- The documentation must be in the name of the tax payer, his or her spouse or father, mother, or children.

Important note: Last year fiscal authority published an internal criteria for public notaries, which states the duty for sellers to provide a fiscal certificate called Form 36 to prove of Fiscal Residence to notaries. To get this certificate the seller must report information regarding previous annual tax return presented in Mexico.

HOW IS THIS TAX CALCULATED?

The basic formula is: Income – Cost – Deductions = Capital Gain

1.- Income is the value of the sale. If no value is given, the amount will be determined by an authorized fiscal appraiser. We have already mentioned how much of income could be exempt in the first part of this article.

2.- Cost is the verified cost of purchase adjusted up for inflation. It includes cost of land and
construction. From the cost of purchase you subtract the cost of the land and the result will be the cost of construction.

3.- Deductions.- Taxes and expenses related to the purchase of the home (closing costs), which be documented with a factura (most people do not get the factura of closing costs when they purchase).

WHAT CAN WE CONSIDER “COSTS”?: General rules are:
1.- Cost of construction.- When costs of the land and construction are not clearly established on the deed, the default rule is to consider 20% of the purchase price as the price of the land OR the amounts set in the appraisl for land and construction.

Construction costs depreciate at 3% per year and cannot fall below 20% of the initial cost. The resulting cost will be adjusted up for inflation.

2.- Improvements that imply deductible investments are subject to the same depreciation schedule, and must be supported with documentation (“facturas” in seller’s name).

3.- Maintenance is not a deductible expense.

4.- Estimation of construction cost. When you did not keep any records (facturas) for the building, improvements or a remodel, you still have the fall-back position to use 80% of the value of appraisal of the construction at the time of its completion. In order to register this value a procedures needs to be conducted before the municipal authority.

Several other rules apply to cost of construction and we recommend that you have an advisor go over these with you.

DEDUCTIONS:

For the sale of homes, deductions are very limited, and include:

Notary fees and expenses by deeds of acquisition or sale (with a factura)

Local tax on transfer of title that you paid on closing and you should have a receipt for in your closing documents.

Payments made for the appraisal of the property.

The real estate commissions you paid (if any) when you bought. Again you must have a factura for this. All the above deductions must have the proper documentary support and should be adjusted up for inflation.


CAPTIAL GAINS AMOUNT AND CALCULATION:

As we mentioned above, the calculation, withholding and provisional payment of this tax will be done by the public notary. The payment of this tax is determined on a scale that starts at 6.4% and goes to 30%.

CAPITAL GAINS ON THE SALE OF A HOME OWNED BY “NON FISCAL RESIDENTS” IN MEXICO.

If you are considered a Non-Fiscal Resident of a home, you will pay the following taxes on the sale of a home. You have the option of paying :

25% over total sale amount WITHOUT ANY DECUDTIONS, or
30% over the capital gain. Formula: Income – Cost – Deductions = Capital Gain.

Note.- Option 2 only applies when:
The seller has a legal representative in Mexico, or

The transaction is formalized via a public deed (before a Notary).

THERE IS NO EXEMPTION ON THE SALE OF HOME FOR SOMEONE THAT IS A NON-FISCAL RESIDENT.

FINAL COMMENTS


Mexico has created new rules and closed “loopholes” that previously existed in the tax laws pertaining to the sale of homes and the exemption of taxes. This, coupled with the difficulty in determining the tax and the lack of a true tax paying “culture” in Mexico has cause notaries to resort to techniques such as:

Considering all foreigners as “NON FISCAL RESIDENTS” .
Considering that a person who does not have an RFC (prior to the sale) to not be able to acquire the exemptions allowed by the law.
Soliciting additional documentation not required by the law to prove that a property is a primary residence.
Not allowing authorized deductions even though they comply with all the fiscal requirements.
Requesting FM2’s with specific text or addresses mentioned in them.
Making errors in calculations.
Etc.

TAKE THE TIME AND SPEND THE MONEY TO GET AN INDEPENT OPINION (NOT JUST THE NOTARIES) OF WHAT YOUR CAPTI GAINS TAX WILL BE. The above information should put you in a position to have a general and correct understanding of how this tax is calculated. If someone is telling you something different, more often then not, they do not have a correct or complete understanding of the current tax laws, and you should look for other counsel. No one wants to pay taxes, but we have to. Looking for the legal manner to pay the least amount of taxes is what you should do. Taking the time and get the right advice could save ten of thousand of dollars.

The present article is a general overview of current tax issues valid at the moment of this publication. For each specific case we recommend that you acquire a written opinion of you actual tax liability.

 

"That article may be contrary to the interpretation of the tax authorities"

 

This article was written jointly by Everardo Teran, Gabriela Rojas and David W. Connell. More articles and seminars by Mr. Teran, Ms Rojas and Mr. Connell can be seen at www.mexicanaccountant.com, www.mexicolaw.com.mx . The present article is property of Connell & Associates and its reproduction of use requires the express written authorization of Mr. Teran and Mr. Connell, who reserve all right over this work. Copyright 2010.