Sunday, January 30, 2011



By Don D. Nelson, Attorney, CPA

When you are renting out your real property in Mexico, as a US Citizen or permanent resident, you must not only comply with all Mexican tax requirements but you must also comply with the Internal Revenue Service's US income tax return filing requirements.  The rules are almost the same as those for rental property located in the US, but with some variations.

·         If you own the Mexican rental property through a Fideicomiso, or outright in your individual name, you report all of your rental income and expenses on Schedule E of your Form 1040.  All of the allowable expenses are the same as for US property.
·         Expenses you can deduct include management fees, interest, property taxes, utilities, repairs, maintenance, association dues, insurance, depreciation, and other miscellaneous expenses.
·         Unlike property located in the US, you must depreciate the property (amount allocatable to the structure) over a 40 year period rather than shorter times sometimes allowed for US property.
·         You can take a credit against your US federal income tax for income taxes paid to Mexico on your net rental income after deducting all expenses.  That credit is limited to the amount of US Federal tax you paid on that rental income on your tax return.  Any unused foreign tax credit can be carried over to future year.  Most states do not allow any credit for income taxes paid foreign countries. That credit can be taken for Mexican income taxes and any income tax imposed by a State in Mexico. That state tax income  is 3% in Baja California Sur. Some states in Mexico have no income tax.
·         Any IVA or occupancy tax collected from the renter should be included in your rental income, but then you can deduct out those  taxes so you do not have to pay any tax on those items.  IVA in the Baja California is 11%  and 16% in much of the rest of Mexico.
·         The  same restrictions and limited allowable deductions for “vacation homes” apply when you have occupied the property yourself part of the time and rented it out to third parties at other times.
·         When the property is sold (if it is held in your individual name or in a Fideicomiso) your  net gain is taxed in the US at the applicable lower capital gains rates, and you can claim a credit against your US tax on the sale for Mexican capital gains taxes paid on that profit to Mexico.

If the property was used for the 2 years during the previous 5 years prior to sale as your personal primary residence (you must actually live in it full time during that period), you may be able to exclude up to $500,000 of the gain from your US income taxes under the exclusion allowed for sales of personal residences. If the property was rented out part of that time, some of the gain on sale will be subject to US income tax.

If your Mexican property is held through a Mexican corporation, there can be adverse US tax consequences while renting out the property and upon sale on your US tax return.  With the proper type of Mexican corporation, certain elections with the IRS can be made for US tax purposes which will negate almost of these US tax problems.  These elections are only made for US tax purposes and do not in any way affect the way your Mexican corporation is taxed under Mexican law.

Other  US Tax Forms That May be Required:

Form 3520/3520A:      If you own your Mexican rental (or personal residence or second home real property) through a Fideicomiso, you must file these forms each year to avoid extreme penalties.  These forms are filed separately from your personal return.  The first form is due on March 15th following the end of the calendar year and the other form is due on the extended due date of personal tax return.

Form 5471:  If your Mexican real estate is held in a Mexican corporation, you must file this form each year if you own 10% or more of the shares (actually or constructively) in the corporation. This form is due on the extended due date of  your personal return. The IRS can impose a $10,000 per year penalty for filing this form late or not at all.

Form TDF 90-22.1:  This form reports your ownership in foreign bank and other financial accounts. It would include any accounts where your property manager or accountant is using to collect rents or pay Mexican taxes and rentals. If the highest total of all of your foreign financial and bank accounts when combined together equal or exceed at any time $10,000 US per year, you must file this form to report details of all accounts.  It is filed separately from your tax return and is due on June 30th following the end of each calendar year. The due date cannot be extended. The IRS can impose a $10,000 penalty for filing the form late or not at all.

Mexico Also Taxes Rental Income:  Mexico imposes income taxes, IVA and other taxes on all rental income derived by Landlords from renting properties in Mexico.  You must pay these taxes even if you do not live in Mexico. The rules are complex and failure to comply with those rules can result in serious monetary and other problems with the Mexican taxing authorities. We recommend you contact a Mexican accountant, or rental property tax expert to learn what it takes to be in legal compliance with those Mexican tax laws. The Settlement Company at  has an excellent service helping  those who own Mexican rental property comply  with Mexican rental tax laws and returns.

 Our other Expatriate Tax Blog with latest worldwide news:

Skype address: dondnelson

Wednesday, January 26, 2011

Wall Street Journal Reports Ten Ways to Avoid an IRS Income Tax Audit

The Wall Street Journal has reported 10 ways to avoid a tax audit. The most useful is to report your business income in a corporation or LLC which can avoid the use of a schedule C on your personal tax return. It states that using a schedule C to report your business income can result in your chance of being audited being 10 times higher using a corporation. Read here for other tips and recommendations.

Sunday, January 23, 2011

US Estate Planning if you Live and Work In Mexico

You cannot ignore estate planning if you wish your US and and Mexican assets passing to the heirs you desire. You  need to take the necessary steps to keep the costs and taxes at a minimum.  If you are a US expat living in Mexico, that means you have to put the necessary documents in place in Mexico  and in the USA.  The laws of both countries governing testate succession must be coordinated.

The US imposes its estate and gift taxes on your no matter where you live in the world and no matter where your assets are located in the world.  Mexico currently has no estate taxes but they are talking about changing that.

The US side of the process involves Wills, Trusts, Powers of Attorneys and Health Care Directives.  These documents will direct the disposition of your Assets located in the USA.  It may also involve a program of gifting in order to keep your US taxes down.  In Mexico you may need a Mexican Will and must take steps to make certain your Fideicomiso passes your Mexican real estate to the proper heirs. You will need a Mexican attorney or accountant to help you with these documents.

  If you do it right, you can save tens of thousands of dollars in probate fees,and often a lot more in estate taxes.  We have been doing estate planning for over 30 years.  Read more and download your estate planning questionnaire here.  After you fill it out, send it to us and we can help you implement a plan that achieves your personal wishes.

Even Mexicans who are not US Citizens or residents, need to do US estate planning if they have real estate, corporations, or other assets located in the US.  Proper advance planning also saves a lot of costs your heirs will have to incur if it is not done in advance.

Wednesday, January 12, 2011

New Estate Tax Law Rules - For US Expats and Residents

We want to apprise you of the estate and gift tax changes in the recently enacted 2010 Tax Relief Act. Remember if you are a US Citizen no matter where you live in the world and no matter where you live in the world you are subject to US estate taxes on your worldwide assets. In some situations you can claim a credit for an estate taxes which must be paid in foreign countries against your US estate taxes.  Before the new law, there was no estate tax for 2010, but some beneficiaries could have faced higher taxes because there were less favorable income tax basis rules. Also, under the prior law, estate and other transfer taxes were scheduled to rise substantially for post-2010 transfers.
Overview of the new law. The 2010 Tax Relief Act provides temporary relief. Among other changes, it reduces estate, gift and generation-skipping transfer (GST) taxes for 2011 and 2012. It preserves estate tax repeal for 2010, but in a roundabout way: estates wanting zero estate tax for 2010 must elect that option, along with the less favorable modified carryover basis rules that were set to apply for 2010. Otherwise, by default, the estate tax is revived for 2010, with a $5 million exemption, a top tax rate of 35%, and a step-up in basis. Also, for estates of decedents dying after Dec. 31, 2010, a deceased spouse's unused exemption may be shifted to the surviving spouse. However, these generous rules are temporary—much harsher rules are slated to return after 2012.
Lower rate and higher exemption for 2011 and 2012. For estates of individuals dying in 2009, the top estate tax rate was 45% and there was a $3.5 million exemption. The top rate was to rise to 55% for estates of individuals dying after 2010, and the exemption was to be $1 million. For 2011 and 2012, the 2010 Tax Relief Act reduces the top rate to 35%. It also increases the exemption to $5 million for 2011 with a further increase for inflation in 2012. But these changes are temporary. After 2012, the top rate will be 55%, and the exemption will be $1 million.
Special tax saving choice for 2010. The 2010 Tax Relief Act allows estates of decedents who died in 2010 to choose between (1) estate tax (based on a $5 million exemption and 35% top rate) and a step-up in basis, or (2) no estate tax and modified carryover basis. Basis is the yardstick for measuring income tax gain or loss when an asset is sold. With a step-up in basis, pre-death gain is eliminated because the basis in the heir's hands is increased to the date of death value of the asset. On the other hand, with a modified carryover basis, an heir gets the decedent's original basis, plus certain increases, which can be substantial. Even so, if the decedent had a relatively low basis and significant assets, some pre-death gain may be taxed when the heir sells the property. These concerns factor into the special choice for 2010. The executor should make whichever choice would produce the lowest combined estate and income taxes for the estate and its beneficiaries. This would depend, among other factors, on the decedent's basis in the assets immediately before death and how soon the estate beneficiaries may sell the assets.
Gift tax changes. Years ago, the gift tax and the estate tax were unified—they shared a single exemption and were subject to the same rates. This was not the case in recent years. For example, in 2010, the top gift tax rate was 35% and the exemption was $1 million. For gifts made after Dec. 31, 2010, the gift tax and estate tax are reunified and an overall $5 million exemption applies.
GST tax changes. The GST tax is an additional tax on gifts and bequests to grandchildren when their parents are still alive. The 2010 Tax Relief Act lowers GST taxes for 2011 and 2012 by increasing the exemption amount from $1 million to $5 million (as indexed after 2011) and reducing the rate from 55% to 35%.
New portability feature. Under the 2010 Tax Relief Act, any exemption that remains unused as of the death of a spouse who dies after Dec. 31, 2010 and before Jan. 1, 2013 is generally available for use by the surviving spouse in addition to his or her own $5 million exemption for taxable transfers made during life or at death. Under prior law, the exemption of the first spouse to die would be lost if not used. This could happen where the spouse with resources below the exemption amount died before the richer spouse. One way to address that was to set up a trust for the poorer spouse. Now, the portability rule may make setting up a trust unnecessary in some cases. But there still may be other reasons to employ credit shelter trusts. For example, a credit shelter trust may protect appreciation occurring between the death of the first spouse and the death of the second spouse from being subject to estate tax. Such a trust also can protect against creditors. Plus, the transferred exemption may be lost if the surviving spouse remarries and is again widowed.
Conclusion. The estate tax relief in the new law is substantial, but it is temporary. Estate planning to reduce taxes remains an important consideration. Even if taxes are not a concern because an estate is below the exemption level, it is important to have a proper estate plan to ensure that the needs of intended beneficiaries are met. Please schedule an phone appointment (we do use skype) with us to discuss how you and your family can make the best use of the new estate and gift tax rules.

Thursday, January 6, 2011

Forms 3520 and 3520A Still Due for Fideicomisos Which Hold Title to your Mexican Real Estate

Though many commentators have written articles stating that Mexican Fideicomisos should not have to file the Foreign Trust US Tax  Forms 3520 and 3520A, the IRS has not in writing or any other manner accepted that position.  They apparently do not plan on making any announcement on the status of Fideicomisos.  Their  refusal to take a position clearly indicates that the Form should be filed.  A Fedeicomiso is worded like a foreign trust and does hold title to Mexican real estate on behalf of  the real owner.  It is administered by a Mexican Bank which acts as a Trustee.  The IRS obviously likes the fact  the these Forms will keep them fully informed of  all of the real estate owned by US Gringos in Mexico and therefore force those Gringos to report any income made from those properties. Failure to file these forms can result in a $10,000 per year penalty.  The Form 3520 A is due on 3/15 unless the due date is extended.

If you own non residential property  through a Mexican Corporation, you must file Form 5471 each year  or risk the same high penalty. This form is due on the extended due date of your personal tax return.

All rental income earned by your Mexican property must be reported on your US tax return but if it is held through a Fideicomiso you can claim a foreign tax credit for the taxes you pay on that income in Mexico.

Monday, January 3, 2011

New Form 8938 Required to Report Foreign Financial Assets For Tax Years Beginning after 3/18/10

For tax years beginning after 3/18/10 you must now file form 8938 to report your foreign financial assets if the total value of those assets equals or exceeds $50,000 in that taxable year. The final form and instructions defining those foreign financial assets which are included have  not yet been released .