Tulum, Cabo, Cancun, and Playa del Carmen are not only wonderful vacation destinations in Mexico, they are also very attractive destinations for American investors. Clients interested in acquiring real estate in Mexico, often inquiry about recommended structures to acquire real estate in coastal Mexico and the tax implications from such investments.
This article provides a general overview of the process to acquire real estate in Mexico, as well as the most common legal and tax implications with respect to such investments in the U.S. and Mexico.
Generally, non-Mexican citizens can legally acquire real estate within Mexico areas. Although Mexican law may prohibit such investors from directly acquiring or holding real estate in certain areas of Mexico. This restriction is established in the Mexican Constitution and applies to an area known as the “restricted zone” (zona restringida). This area encompasses 100km (approx. 62 miles) in the border area and 50km across the coastal zone of Mexico (approx. 31 miles). Under the applicable Mexican law, non-Mexican citizens cannot directly hold real estate in the restricted zone. For example, a U.S. investor may not acquire real estate in any of the coastal areas of Mexico and hold it for residential purposes.
Fortunately for foreign investors, there are legal avenues to overcome these restrictions. A U.S. investor seeking to acquire real estate within the restricted zone, may seek to acquire the property through a “Mexican Trust” (fideicomiso). A fideicomiso has the flexibility for real estate acquisitions or the pursuit of certain business endeavors, such as construction in Mexico.
A Mexican Trust created by a U.S. investor to acquire real estate within the restricted zone serving purpose is to hold title to the property. The Mexican Trust has three participants: (i) a fideicomitente (or grantor) who is the foreign investor that contributes the assets to acquire the real estate in Mexico, (generally cash); (ii) the fiduciario (or trustee), which is a licensed financial institution in Mexico that will act as a trustee of the assets contributed by the fideicomitente, and who will use such assets to acquire the real estate; and, (iii) the fideicomisario is the beneficiary of the Mexican Trust. The beneficiary is often the same individual as the grantor.
Once the foreign investor (grantor) contributes money or assets to the Mexican Trust, the Trustee will allocate such assets to acquire the real estate. The Mexican Trust holds title and ownership of the property. However, under the terms of the Mexican Trust, the foreign investor is allowed to use the real estate, sell the property, and collect rents from occasional leasing.
Mexican tax implications of a Mexican Trust
The tax implications on a fideicomiso in Mexico vary depending on the income received and its purpose. Generally, under Mexican tax laws, a Mexican Trust characterizes as either passive or active. A passive trust derives more than 90% of its income from passive sources (such as rents, capital gains, interest, etc). A passive Mexican Trust is treated as a “transparent” or “pass-through” entity for Mexican tax purposes. As such, the grantor (foreign investor) is the person that will be subject to taxation on the income derived from the Mexican Trust.
Note that foreign investors are generally subject to withholding. The Mexican trustee is required to make the appropriate tax withholdings, which depend on the type of income derived from the Mexican Trust.
The withholding income tax rate from leasing real estate is 25% of the gross income. The Mexican Trust is required to issue a digital tax invoice on behalf of the individual U.S. tax resident to the tenant.
Additionally, a 16% Value Added Tax rate may apply to such transactions. Taxpayers are required to issue digital tax invoices in such transactions. However, the taxpayer may opt for the Mexican Trust to issue the corresponding tax invoices on its behalf under the Value Added Tax Law (VAT Law), to avoid the additional administrative burden. The VAT is not creditable in the U.S.
Considering the above, for example, if an individual U.S. tax resident obtains rent from leasing real state through a passive Mexican Trust, and elects to have the Mexican Trust issue the corresponding tax invoices under the VAT Law, then the Mexican Trust would be required to withhold 25% income tax rate and 16% VAT over the rents and issue the corresponding digital tax invoice on behalf of the U.S. taxpayer.
U.S. tax implications for a Mexican Trust
U.S. tax residents who hold an interest in a Mexican Trust face several potential implications depending on the circumstances.
First, the income derived from the Mexican Trust is subject to income tax in the U.S. U.S. tax residents are required to include income from whatever source derived by a U.S. citizen, including the income derived from Mexico. A U.S. tax resident includes a U.S. citizen, a green card holder, and any person that is substantially present in the U.S. For example, a U.S. corporation that is the grantor in the Mexican Trust would be subject to taxation at the 21% tax rate on the income derived from the Mexican Trust. Alternatively, a U.S. individual would be subject to progressive tax rates (up to 37%) on income derived from the Mexican Trust. Given the differences in tax rates, opportunities may exist for tax planning. Second, the U.S. investor may be able to claim a credit for the tax withheld by the trustee of the fideicomiso. New IRS regulations may impact qualifications for the Foreign Tax Credit.
Third, U.S. investors may face implications if the property in Mexico is continuously rented, potentially, triggering a “foreign branch” for purposes of the foreign tax credit limitations.
U.S. persons may also face reporting requirements. A Form 3520 may be required with respect to foreign trusts. However, in Rev. Rul. 2013-14, the IRS ruled that Mexican Trusts used merely to hold title to property are not considered “trusts” for purposes of Form 3520. Accordingly, such fideicomisos may fall within Rev. Rul. 2013-14. However, the Revenue Ruling does not apply to all types of fideicomisos, nor does it apply to all fideicomisos that are used to hold real estate. Its application is limited to three different types of fideicomisos in which the real estate is “occasionally leased.”
The Revenue Ruling expressly excludes other types of fideicomisos (beyond holding legal title of the real estate) including those where the trustee is required to carry other activities, where the fideicomiso holds title to any other property (for example, stocks), or where the real estate is primarily leased. In all these cases, the fideicomiso may give to a different tax treatment and reporting obligations, including Forms 8938, 3520 and FBARs.
Acquiring property in Mexico’s coast requires careful consideration of the tax implications. A U.S. investor should determine the most advantageous structure to acquire such property in order to minimize potential tax risk and to maximize the enjoyment of the beautiful sun and sand.
Need help with tax issues? Contact us as soon as possible to discuss your rights and the ways we can assist in your defense. We handle all types of cases, including complex international & offshore tax compliance. Schedule a consultation or call (214) 984–3410 to discuss your international tax concerns or questions.