Monday, June 3, 2013

A True Story of the Consequences of Not Reporting the Sale of Mexican Property to IRS

Individual X owned a property in Baja California along the coast for about 14 years. During that time he built it up and made lots of improvements. Never got receipts or kept records of the costs of the improvements  Several years ago he sold it for about 1.6 million US dollars, but since he was told no one every told the IRS about sales of property in Mexico he did not include that sale on his US tax returns.  Also due to a helpful notary when he sold the property he paid very little capital gains taxes to Mexico on his large gain.

A year following the sale the IRS decided to audit because  sale of his Mexican property  was not reported on his US.  No one has ever determined how they found out about that sale, but they did have a lot of information on it.  X could not blame his accountant because he never told him about the sale.  The auditor told X he thought he should report the sale to the IRS Criminal Investigation Division but continued to conduct the audit of his return.  X had many problems in that audit:

  • He did not have support for the cost of all improvements he made to the property and thus reduce his capital gain.
  • Due to the helpful Mexican Notary, he had paid only a small amount of capital gain taxes in Mexico and therefore had only a small amount of  foreign tax credits to  offset the $389,000 plus in US taxes, interest and penalty assessment resulting from the audit.
  • He had never filed the required form 3520 and 3520A which are required to be filed when you are a beneficiary and grantor of a foreign trust such as the Fideicomiso's which Mexico requires when foreigners own property along the coast in Mexico.
  • He did not have any explanation why the sale was not shown on his US tax return.
If X had kept good written records of the significant improvements made to the real estate, and paid the Mexican capital gain taxes which would normally be assessed (without the helpful Notary) he would have most likely owed no US taxes on the gain on sale.

At the conclusion of the audit, as a result of  innovative representation from X's attorney and CPA, and the good luck of have been assigned to a compassionate IRS auditor (this does not always happen) all he had to pay  were the taxes, interest and penalties. He did not get criminally prosecuted for tax fraud and go to jail for 5 years which would most likely happen to US taxpayers under these factual circumstances.

If you have failed to report real estates sales in Mexico, or rental income, or are purchasing real estate contact us to learn more about your options and how to solve past non-reporting problems. 

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