Buying and Selling Real Estate in Mexico - Reality Check on Enforcement of the Contract

When you buy or sell real estate in Mexico brokers and agents sometimes tell you that everything is done differently in Mexico than in the USA.  While in many respects, there are some differences, many parts of the process are remarkably similar to the USA.  Therefore, you should make sure your contract contains the same protective clauses and paragraphs you will find in a US contract of sale.   Using the California Association of Realtors contract as a guide is a good place to start when reviewing the contract given you by the RE agent, and making changes and improvements.

Where their may be some differences in the law, there are hugh differences in the enforceability of the contract.  Why?  The difference arises due to the Mexican legal systems, courts and the extremely long time in many areas of Mexico it takes to get a judgement or decision.  It can easily in some areas of Mexico take 5 or more years to get a judgment and sometimes due to factors not usually encountered in the US, the decision in any lawsuit may not be the correct one.

What is the solution?  Write a good contract and in the event a dispute arises, make certain it contains a mediation and arbitration provision.  The arbitraion laws are excellent in Mexico and if you and the other party agree to arbitrate it is likely you will resolve your dispute within  8 to 12 months.  That decision is then entered into the Court as a judgment.  Most arbitration are binding and cannot be appealled ( unlike most Court judgments in Mexico which are often appealled adding many more years to the final decision).

If you want to learn more about arbitraion or mediation, the clauses to put in your next contract, and how to have a dispute arbitrated or mediated, email us a ddnelson@gmail.com   If all parties agree, you can even remove your case from the Courts and have it decided by arbitration.  It is even legal to have the arbitrator be a US attorney or a panel of US and Mexican attorneys with real estate experience. Due to the speed of the process, you may save a lot of money in costs and attorneys fees.

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.

www.TaxMeLess.com     www.expatattorneycpa.com 

Mexican Taxes on Sale of Mexican Property

You can pay 28 on the net profit on the sale of Mexican property to the Hacienda or chose to pay 25% on the gross proceeds from the sale. This is not as bad as it seems since your cost basis is adjusted up for inflation over the years that you own the property.  Read the details of the Mexican tax on property sales as set forth HERE by Snell Real Estate in Cabo San Lucas.

You do get to claim this tax as a credit against your US tax on the gain (if you owned the property individually or through a fideicomiso) which does avoid double taxation.

If you own the property in your individual name or through a fideicomiso, you can utilize or US tax purposes the $500,000 gain exemption if married (or $250,000 if you are single) on sale if you occupied it for 2 out of the last five years as your primary residence.  The primary residence gain exclusion has much tougher requirements under Mexican tax law, but those rules do not apply for US tax purposes.

The surprise arises when you sell your Mexican property that was held in a Fideicomiso and you failed to file the IRS required forms 3520 and 3520A each year.  You could incur substantial penalties for failing to file those forms or all of the years you owned the property. Sometimes those penalties can be abated.

Another problem arises when you held your Mexican real estate through a Mexican corporation and you or other US taxpayers owned more than 50% of that corporation.  Due to that manner of ownership, it could prevent you from claiming the foreign tax credit for the Mexican capital gains taxes you paid and cause you to pay high US taxes on the gain when it is distributed from your corporation which is often double taxation.

What is the solution?  When you purchase property in a Mexican corporation make certain it is the corporation known as SRL de CV.  That Mexican entity (and none other) is eligible or US tax purposes  to elect flow through status (for US tax purposes only- this election does not affect the Mexican taxes) which means any gains on sales will be taxed at US capital gains rates (if you held the property for more than a year) and you can offset that tax with the Mexican gains tax you paid on sale.  It totally avoids any possibility of double taxation.  Ask us how.