Just as in the United States or Canada, the foreigner selling his trust rights in real estate must pay a tax on his profits to S.A.T., previously known as Hacienda, Mexico’s version of Uncle Sam. None of us like to pay taxes but we’ve become accustomed to paying them in our own countries and, believe it or not, Mexico’s tax is probably no worse than what we would pay at home.
Lots of foreigners would argue with that statement and justifiably so…. in their particular cases. It is critically important to know how to structure the purchase and sale. For this reason it is recommended that professional advice be obtained both at the time of purchase, and at the time of sale.
Let’s consider John and Mary Smith. They arrived in Los Cabos in June, 1998 and paid 75,000 U.S.D., in cash, to the developer for their condominium at XYZ Plaza. Additionally they paid another 5,000 U.S.D. in Notary fees, transfer taxes, bank fees, etc. to obtain their deed. (2,000 U.S.D. of this was specifically identified as Notary fees, appraisal fees and acquisition tax.) Their principal residence is in North Dakota. They’ve used the Los Cabos unit less than they hoped, so in March 2003 they sell it to Mr. and Mrs. Jones for 75,000 U.S.D. They are sure there will be no capital gains tax on their sale, since it would appear that there is no profit on the sale.
Are they right?
NO! ……….WRONG!
In a review of their deed it is found that THE VALUE DECLARED IN THE TRANSACTION was the equivalent of approximately 30,000. U.S.D., which was the appraised value in June, 1998 at the time they purchased the property. Thus, for tax purposes, John and Mary Smith have a cost basis for their property of 30,000 U.S.D. even though they actually paid 75,000 U.S.D. for it!
Now, at the time of sale to Mr. and Mrs. Jones, the appraised value is the U.S. equivalent of 60,000 U.S.D. (March 2003)
Since the law states, however, that the amount to be declared in the transaction is the HIGHER of (1) current appraisal value, (2) property tax value, OR (3) current selling price, 75,000. U.S.D. is the amount which must be declared by Mr. and Mrs. Smith, not the 60,000 U.S.D. appraisal value, nor the 30,000U.S.D. property tax value.
Those buying property today should INSIST upon having the full purchase price or its equivalent in Mexican pesos, declared in their deed when made before the Notary Public. This means they will be paying more in acquisition tax, currently at 2 percent of declared value, when they purchase. This levels the playing field, however, and sets the scene for fair and reasonable tax treatment when the property is sold.
Buyers who insist on declaration of their full purchase price will meet resistance from sellers, however, who ignored or were unaware of the law when they, the sellers, purchased. Consider Mr. and Mrs. Smith, they have a tax basis of 30,000 U.S.D. for their condominium unit, with a selling price of 75,000 U.S.D. The Smiths will show a gain of 45,000 U.S.D., even though they are selling at the price they really paid for the unit.
The tax is 25 percent of the total amount of the sale or 33 percent of the difference between the sellers’ declared value and new declared value, LESS adjustment for inflation and allowable expenses.
The adjustment for inflation is geared to a consumer price index published by the Mexican government monthly. The 30,000 U.S.D. cost basis adjusted for inflation from July 1, 1998 to March 30, 2003 becomes 38,788 U.S.D., also taking into account the depreciation of the building from date of purchase to date of sale. Mr. and Mrs. Smith also had 2,000 U.S.D. of allowable deductions (notary fees, acquisition tax and appraisal fees); 5,000 U.S.D. of improvements in October 1999; and are paying a 7,500 U.S.D. commission, plus IVA. The cost basis of 30,000 U.S.D. (today 38,788 U.S.D.), plus costs adjusted to current value and commissions amount to 16,474 U.S.D., which adds up to a current cost basis of 55,262 U.S.D. This amount subtracted from the 75,000 U.S.D. current sale price leaves a profit of 19,738 U.S.D.
Based upon the 35 percent rate, the tax will be 6,908.30 U.S.D.
Based upon the 25 percent rate, the tax will be 18,750 U.S.D.
Since the law states that the LOWER amount is the tax due, Mr. and Mrs. Smith will have a capital gain tax of 6,908.30 U.S.D., which must be paid in Mexican pesos.
In this transition period between DECLARED value and REAL value, buyers may need to be prepared to assist sellers caught in this bind, with their capital gains tax payment in order to make the purchase. The Mexican government is enforcing the law as written. Foreigners buying properties need to be aware of this law and set the stage at purchase in order to avoid financial loss when selling.
It is also important to remember that the adjusted current value will be affected by not only adjustments for inflation, depreciation of the constructions from date of purchase to date of sale but also, the exchange rate at the time of purchase and the exchange rate at the time of subsequent sale, if U.S. dollars are used in the transaction. Thus a purchase registered in Mexican pesos in 1993 when the peso was approximately 3.00 per dollar will have a lower dollar value in 2003 when the exchange rate for the Mexican peso is approximately 10.50 pesos to 1.00 U.S.D. In order to avoid losses of this type it is recommended that the value be declared in U.S. dollars and the rate of exchange mentioned in the deed.
Sale of Primary Residence
If you are selling your primary residence you may be permitted an exemption from the ISR (capital gains tax). Foreigners who claim this exemption should be tax residents of Mexico and have all documents in order in order to obtain this exemption.
