by Don D. Nelson, Attorney, CPA, International Tax Expert
If you own real estate in Baja Sur, almost everything you need to know about the US IRS tax reporting rules on that Mexican real estate are reported in this article. The rules are complex, but if you plan ahead, your Mexican real estate can benefit you on your US tax return.
Owning a Full time residence in Baja Sur
The US tax rules are the same on your US return whether your primary residence is located in the US or in Mexico. You can deduct the interest on the mortgage you incur to purchase the property on up to a 1.1 million dollar mortgage and you can deduct the property taxes you pay on the property. Both of these are deducted on Schedule A as itemized deductions. When you ultimately sell the property up to $500,000 of gain on the sale will be exempt from US taxes if it was your primary residence for 2 out of the 5 years prior to sale. Your gain on sale may also be exempt from Mexican taxes if you fill all of Mexican tax law’s criteria. You should consult a Mexican CPA to determine the Hacienda’s criteria.
Part time residence
Again the rules are the same as for a second home in the US. You can deduct property taxes and interest (subject to the limitation of the amount for deductible interest on your first and second home under US tax law) on Schedule A as an itemized deduction.
Rental Property
Mexican rental property held through a Fideicomiso or in your individual name is treated the same as a rental property in the US and reported on Schedule E. The only primary difference is that you must depreciate the property over a 40 year period versus 27.5 year period for a US residential rental property. Of course if you pay Mexican income taxes on the net rental income (and you are required to pay Mexican income tax on that income!) you can take it as a credit offsetting any US federal tax on the same income dollar for dollar. Most states do not allow foreign tax credits. You can also deduct IVA tax you are required to pay on rental income in Mexico on your US return also
If your Mexican property is used part time by you and is rented out part time as a vacation rental, the US tax vacation rental limits may reduce the amount of deductions you can take on the property. Read more about Vacation Rental rules and limitations in IRS publication 527.
IRS Disclosure
Though there are special forms which must be filed with the IRS to report on foreign bank accounts and foreign financial assets (form 8938) real estate held in your own name (or through a fideicomiso) is not required to be reported anywhere on your tax return. If the real estate is held by a Mexican partnership or corporation that entity may have to be reported on the foreign financial assets form. The fact that there is no required IRS reporting may account for many of the very expensives homes in Baja Sur that seem to be used very rarely.
Mexican Corporations
If you own commercial property and it is in the restricted zone (which is a large part of Baja Sur) and you follow Mexican law you must as a foreigner own it through a Mexican Corporation. You are required to file form 5471 and sometimes form 926 reporting that ownership with your US tax return and capital contributions made to that corporation..
It may be to your benefit to make sure the Corporation is a Sociedad de Responsabilidad Limitada, S. de R.L. Only with this type of Mexican corporation can you make an election for US tax purposes to treat the corporation’s net profit or loss as a flow through to your US tax return which gives you several benefits including (a) claiming foreign tax credits on your US return for Mexican income taxes paid by the corporation; (b) deducting losses from the corporations rentals on your US return to offset other income; and (c) avoid double taxation of the gain on sale (or deducting a loss) when the corporation ultimately sells the property.
Mexican and other foreign Bank & Financial Accounts
You may in connection with your real estate ownership in Baja Sur open a Mexican Bank account or account with a money exchange company. If the combined balances in those accounts at any time during a calendar year are $10,000 US you must file form 114 (filed on line and separate from your tax return) to report those accounts. Failure to file this form can result in a penalty of $10,000 or more. The form must be filed by June 30th following the end of the calendar year and cannot be extended. The Mexican banks are reporting your balances to the IRS.
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About the Author:
Don has been preparing US Tax Returns and providing US tax planning for US Citizens living in Baja Sur for 25 years. He offers his clients the absolute privacy of “attorney-client privilege.” He has assisted numerous Baja residents with the procedures necessary to catch up with past unfiled US tax returns and Foreign Financial Account Disclosure (FBAR and FATCA). His website is at www.TaxMeLess.com and his email is at ddnelson@gmail.com. Phone him in Mexico at 624-131-5228 and in the US at 949-480-1235 .
