Taking the tangle out of taxes

By Don D. Nelson

Attorney at Law, CPA

When you cross the border from the U.S. to Mexico you can leave a lot of things behind but not the tax person. And when taxes take on a Mexican “flavor” it can be confusing. The easiest way to unravel the tangle is to visit a Baja Properties Associate and let them lead you in the right direction.

It is particularly important when it comes to real estate. For example, here are some typical questions our clients ask:

Can I defer capital gain if I sell my residence in the US, and then purchase a new residence in Los Cabos?

You certainly can. The new residence must be purchased at approximately the same price as the sale price.

But there is a time limit. If you plan to make Mexico your permanent residence, you most occupy your new home within four years of the sale of the old.

If your new residence is to be your “primary residence!, you must make a move within two years. Incidentally, you can not get an extension.

To prove you have complied, the IRS may require copies of your utility bill, property taxes , or mail, etc.

What if you change your mind? Well, if you are a qualified permanent resident of Mexico for at least two years before selling your Cabo home, you will owe no Mexican Taxes on any taxable gain.

Nope. The US tax law was amended several years ago. No longer can you realize a tax deferment on the exchange of US investment property to a property located in a foreign country.

There is , however, a way to invest in Los Cabos rental property without having to pay any capital gain tax.

If you have sufficient equity in your U.S. property you can refinance it, or secure a second mortgage. You can then invest those founds in Los Cabos rental property. The interest on the loan will be deductible (subject to certain limits).

This strategy is appealing because it is often difficult to get long terms loans with low interest rates on properties purchased in Mexico. Again, it’s best to discuss it with your tax advisor.

The rules are the same for foreign rental properties as they are in the U.S. you must report all income and can deduct all expenses relating to the property exceed $25,000 per year. You also can depreciate as you would for a U.S. owned property.

Credit can be claimed on your U.S. return for any Mexican Income Taxes. But it must be “income tax” and not “value added tax”.

Another tax law difference is, tenants in Mexico are supposed to withhold taxes from the rent payments and to pay it the Mexican Tax authorities. This is often neglected.

There certainly are if you make Mexico your permanent residence for 330 days out any 12 months period you get a hefty exemption. Earnings from employment or self-employment are exempt form U.S. income tax in amounts up to $70,000 per taxpayer. If you and your spouse work in Mexico, you can exclude up to $140,000.

The exclusion applies only to earned income and does not apply to interest dividends, royalties or rental income.

To claim the benefit you must file a return and meet requirements concerning residency and foreign travel rules.

One other note – if you pay Mexican income taxes on your earnings, you can use those taxes as credits against any taxes you may owe to IRS on the same earnings. That’s to avoid double taxation on the same income items.

Mexico and the U.S. signed a tax treaty with many provisions for tax benefits and reduced rates between the two countries. But it’s complicated. Talk to you tax advisor.

If you own an interest in a foreign corporation, a foreign partnership, or are a beneficiary of a foreign trust (such as the Mexican Real Estate trust), you are required to file a special form each year giving information about your interest in these entities. Additionally, if you have a bank account or have signature authority over a bank account of a U.S or foreign entity, then you must file a form with the Department of Commerce, reporting information about each account. There are tough penalties if you don’t.

The same way you did in the U.S. just remember that all U.S. citizen must file a tax return on their worldwide income regardless of where they live, and whether they are a permanent foreign resident or not.

Recently the U.S and Mexico signed a tax protocol agreeing to exchange information-identifying individuals who are not filing or reporting their income to their home country of residence.

If may take years to implement the agreement but when it is implemented, it could be trouble for people who failed to comply.

Even though you are a resident of Mexico, you still have to file your return by June 15^th. If you owe money April 15 is the deadline, or you will be liable for interest.

But the good news is, If you no longer have any real state in the U.S. you do not have to file any U.S. state tax returns. Mexico has only national income tax-individual states have none.

To avoid tax complications, talk to an expert. If taxes are your concern, get the advice of a U.S. or Mexican attorney familiar with tax laws.

If purchasing real estate, choose an agency with years of experience in Mexican real estate. Their experience and expertise in tax laws can help you avoid mistakes.

It also helps if they are member of Multiple Listing Service, which acts as a watchdog over Cabo Real estate transaction. Each member must follow rules similar to U.S. real estate laws, but it is self-administrated and ensures customers of a full disclosure, of all the costs you will incur purchasing the property and the procedures to follow in transferring the property to a Mexican trust.

Don Nelson is a California attorney and CPA who specializes in international taxation and the tax and legal needs of U.S citizen living in Mexico. He has offices in Westlake Village, Pasadena, CA.

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