It is possible that you along with a large number of US Citizens who own real estate in Mexico are in violating the U.S. Tax law each year when you file their your US returns. That occurs when you fail to file the special forms which are required if you are the beneficiary of a Fideicomiso which is the Mexican trust that owns real estate on behalf of foreigners. A Fideicomiso is required own the property when you are a foreigner and located near the ocean. It is a foreign trust in which you as the property owner are the beneficiary and a Mexican bank acts as the Trustee.
Form 3520A is suppose to be filed by the trustee of your Fideicomiso (the Mexican bank which charges you the annual fee to administer your Fideicomiso) . However, they do not in fact file that form since it is not required by Mexican tax law. Some banks have been reported to want $1,000US or more to look into filing the form and then stated they would want an additional fee if they had to fill it out. If that form is not filed in a timely manner each year (it is due on March 15th following the end of the calendar year) or filed late the penalty is 5 % of the value of the property held in the trust. You will be the taxpayer penalized by the IRS if this form is not filed and therefore, the IRS recommends you file it to avoid having to pay the large penalty. This form reports the information on the income of the trust (if any) and the value of its assets and your contribution to the trust and information on the trustee, the beneficiary and other related information.
Form 3520 must also be filed by you the taxpayer not later than the extended due date of your tax return. It needs to be filed in the year the Fideicomiso comes into being and in years there are distributions or dissolution of the Fideicomiso. Therefore it is not always filed. However, when the form is required to be filed the penalty for not filing it or filing it late is 5% of the value of the trust assets (your real estate). This form reports the name and address of the you, the trustee, when the trust was formed and other details of the trust. The first time is form is filed a copy of the Spanish fideicomiso document is attached to it.
The IRS has not excluded US taxpayers owning property through Mexican Fideicomisos from filing both Forms 3520 and 3520A. They are studying whether they should exempt Fideicomisos from the form but to date no decision has been made. A representative has stated it is a low priority issue. Therefore, you still are required to meet the filing requirements until they state otherwise.
Many US Citizens have said they do not file the form since the IRS could never find out they owned real property in Mexico. Those people are failing to take into consideration the Mexican-US tax treaty which provides for an open exchange of information between the two countries and the fact that when fideicomiso is created it is registered in Mexico with a copy of your U.S. Passport. Starting several years ago your passport is now connected with your social security number. In addition, as more banks in Mexico are acquired by U.S. Banks it becomes more probable that information on these fideicomisos will leak back to the IRS.
An IRS spokesman has orally indicated that if a late filing taxpayer attaches a “reasonable explanation” for the late or previous non filing of these forms, the penalties will be waived. So far that statement appears to been honored for those who have filed late, but it cannot be predicted when the IRS may change this informal policy of waiving the penalty. The IRS also has not defined what is acceptable as a “reasonable explanation.”
An IRS Tax auditor's job is to collect tax money to finance the government. That usually takes a lot of time and effort and reviewing tedious accounting records. Forms such as the 3520 and 3520A which provide for large penalties if filed late or not at all are an IRS auditor's dream. They can collect large penalties for non filing or late filing without conducting a tedious audit. This clearly sets forth a good reason to make certain these forms are filed when each year as required.
Most accountants are not familiar with the 3520 and 3520A forms since they are not involved in international taxation and have no training in that area of tax law. It is best to find an experienced tax expert to assist you with this form or to file any past forms not yet filed.
There is one other tax hurdle that relates to property ownership and your US taxes. If your real property is a commercial or rental property, Mexican law allows you to own it through a Mexican corporation. If that is the manner in which you do hold title to your Los Cabos real estate, each year with your US income tax return you must file Form 5471. Failure to file that form or filing it late can result in a penalty of $10,000 per year.