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 “cliff note” version of what you need to understand. In 2007 the Mexican government modified the rules pertaining to the exemption of income tax obtained in the sale of primary residences. The reason they did this was principally to close loops holes that allowed the upper class to avoid paying taxes on any homes they owned.
In order to understand how the tax authority views a sale we must go through a few definitions:
Definition of “Sale”
For tax purposes a sale of real property occurs when this is:
a) A transfer of property, even those in which the selling party reserves the ownership of the property sold.
b) A transfer of trust (fideicomiso) rights, changing the beneficial rights of the trust.
Definition of “Fiscal Residence”
You are considered a fiscal resident of the country of Mexico when you have established your home in Mexico. However, when you have a home in another country, you will be considered as tax residents in Mexico if Mexico is where you have your “center of vital interests”.
Definition “Center of Vital Interest”
You will be considered to have a center of vital interests in Mexico when more of 50% of the total income comes from Mexico OR when you have set up in Mexico your “main center of your professional activities”.
Note
Tax rule I. 2.1.3. states that you do not have a primary residence in Mexico when you temporarily inhabit a home with tourist, vacational or recreation finalities.
Those are the three definitions and one rule you really need to understand BEFORE we can talk about taxes on the sales of homes and allowable exemptions.
Exemptions on the Sale of a Home for “Fiscal Residents”
• Case 1
When the amount of the sale does not exceed million five hundred thousand investment units (approx: $550,000 USD), the sale is exempt of Income Tax if you are a “Fiscal Resident” of that property. (go back to the definition.)
• Case 2
If you are a “Fiscal Resident”, when the amount of the sale exceeds the above amount, you will pay tax on the amount that exceed such amount (550,000 USD) “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
Sales price $ 1,000,000 dollars
Calculate $ 1,000,000 minus $ 550,000 (exemption amount) equals $ 450,000 (taxable income), which represents 45% of the total sales price. For your cost you can only apply 45% of your purchase price (this would be 45% of $ 300,000) or $ 135,000.
$ 450,000 (taxable income) minus $ 135,000 (Cost) equals $ 315,000. This $ 315,000 is the amount over which your tax will be calculated.
Note
The exemptions herein mentioned only apply to the sale of one home per year.
• Case 3
If you are a “Fiscal Resident” for more than 5 years of a home, the sale of the home is exempt.
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. This is an existing tax rule but we have seen that this rule can be fought and won, making the entire sale exempt. We recommend getting an opinion on this if it is an issue.
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 $500,000 pesos.
Who Calculates the Taxes, How do you Pay it and What Documents do the Ask for to Prove “Fiscal Residence.”
The notary is the person responsible for calculating, withholding and paying the tax on the sale of homes that belong to physical persons (not corporate entities). In our experience most notaries have “tax advisors” 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 experience counsel can sometimes save you tens of thousands of dollars of tax.
In order to prove “Fiscal Residence” you will have to accredit before the public notary that the property object of an operation is your residence with any of the following documents:
I. The voting ID, sent by the Electoral Federal Institute of Mexico.
II. Electrical or telephone receipt.
III. A recognized bank or investment fund statement.
Note
The documentation must be in the name of the tax payer, his or her spouse or father, mother, or children.
How are These Taxes 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.
2.- Cost on Real Property is the verified cost of purchase adjusted up for inflation.
3.- Cost of Construction.- From the cost of purchase you subtract the cost of the land and the result will be the cost of construction. When this separation can not be done you need to consider as cost of the land 20% of the total cost.
Notes and Special Rules Pertaining to Cost of Construction:
When you cannot separate the verified cost of purchase (the part that corresponds to the land and the construction) you are able to consider the proportion that appears in the appraisal at the time of purchase.
The construction costs depreciate 3% a year and can not be below 20% of the initial cost. The resulting cost will be adjusted up for inflation.
The improvements that imply deductible investments will be subject to the same depreciation treatment, and must be count with its respective documental support (Facturas in seller’s name).
Maintenance is not a deductible expense.
Estimation of construction cost. When for any reason the seller cannot verify the cost of the investments in constructions, improvements and extensions done to a building, they will be able to consider as cost 80% of the value of appraisal of the constructions at the time of its conclusion. 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:
Notary fees and expenses by deeds of acquisition or selling.
Local tax by the income by immovable disposition of property, paid by the alienating one.
Payments made on the appraisal of the property.
The commissions paid in the sale or purchase of the property.
All the above deductions must have the proper documentary support and should be adjusted up for inflation.
Capital 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 28%.
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 to pay:
25% over total sale amount WITHOUT ANY DECUDTIONS, or
28% over capital gain. Formula: Income – Cost – Deductions = Capital Gain.
Note
Option 2 only applies when: a) The seller has a legal representative in Mexico, or b) the transaction is formalized via a public deed (before a Notary).
Final Comments
Mexico has created new rules and closed “loop holes” that previously existed in the tax rules pertaining to the sale of homes. This, coupled with the difficulty in determining the tax and the lack of a true tax paying “culture” in Mexico has cause notaries to run into situations such as:
To consider all foreigners as “NON RESIDENTES” for tax effects in Mexico.
To consider 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.
To solicit additional documentation not required by the law to prove that a property is a primary residence.
To not allow authorized deductions even though they comply with all the fiscal requirements.
To solicit FM2’s or FM3’s with specific text or addresses mentioned in them.
To commit errors in calculations, etc.
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. Take the time and get the right advice. You could save ten of thousand of dollars.
The present article is a general explanation 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.
This article was written jointly by Everado Teran Gallegos and David W. Connell.
