US IRS TAX RULES YOU MUST FOLLOW
WHEN YOU OWN AND RENT OUT PROPERTY IN MEXICO
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 www.settlement-co.com has an excellent service helping those who own Mexican rental property comply with Mexican rental tax laws and returns.
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