Capital Gains Tax

By Thomas Lloyd

As in any Real Estate investment or property acquisition, understanding future expenses and estimated revenues determines your future cash flows and returns.

 

Taxes are one of the expenses that will be incurred and therefore you should identify and learn these future obligations when purchasing your second home in Mexico. The largest tax, as is in most countries, is the Capital Gains Tax which we will be discussing in the article below, (� Impuesto Sobre la Renta �).

 

The capital gains tax is collected at the time when you sell your property, and is due by the seller. The Mexican Notary Public is by law, responsible in collecting this tax and forwarding these funds to the Mexican Tax officials within 15 days of collection from the tax payer on the closing date.

 

I will write down a simple example of a calculation listed below from which to base the explanation and article.

 

Two comments before proceeding with the example:

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Let's assume that Joe Smith bought a House in the year 1997 in the month of July.

 

Joe Smith bought the house at the price of $40,000 usd.
In 2007, Joe sold his house in the month of August.
Joe sold his house at the price of $400,000 usd.

 

Example Calculation:

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b) Acquisition Cost. On the Acquisition cost, the notary public will apply a formula to bring the acquisition cost to present value. This formula will take into account the inflation over the years using a Mexican economics factor (INPC) based on the month and year of the purchase and the month and date of the sale of the property. In order to present the numbers of our example in a simple formula, I have not applied any present value factors and will just use the costs from 1997.  Our balance of the profit column will equal $360,000 ($400,000 - $40,000).

 

c) Closing Costs that Joe incurred when he purchased the property. These Costs were incurred in 1997 and the notary public will apply the formula to bring to Present value figures. Again, we will use 1997 costs without applying any present value formulas and our new profit balance figure is $357,600.

 

d) Asset Improvements. These costs will need to be delivered with official Mexican Tax receipts called "facturas". Again, depending on the year these expenses were incurred, the notary public will bring to present value figures. Profit balance totals $338,122.

 

e) Sales Commissions. When Joe sold his property, if he hired professional services to sell his property, these expenses can be deduced. 8% sales commission applied to the sales price of $400,000 gives us a deductible expense of $32,000.  New profit balance equals $306,122.

 

f) Cedula Impuesto. This is a new tax that is collected for the state. This tax is approximately 2% and applied against the profit of the property. This expense is deductible from the calculation on the federal capital gains tax thus applied in this formula.  2% cedula tax on the $306,122 gives an expense of $6,122.

 

g) Capital Gain: After deducting all the expenses permitted by the Mexican government, the sub-total in our example equals $300,000.

 

h) Annual Capital Gain: average gain per year. This figure is obtained by the $300,000 total appreciation divided by the amount of years in possession (10 years).

 

i) Capital Gains Tax: The Annual Capital Gains figure is then used on a tax table along with a simple formula to obtain the tax amount payable.  Rates on this table can range from 3%, 10%, 17%, 25%, and up to 28% depending on the taxable quantity.

* in the majority of the cases the 28% tax rate will be applied.

In our example we will use the 28% applied to the $300,000 profit to determine the tax due.

 

Now most of the questions that I receive regarding capital gains tax are �how can I reduce or avoid this tax?� My response is �you should prepare your pro forma with the calculation that you WILL PAY this 28% tax. In some cases where the Mexican Foreigner is actually exempt, then your tax expense savings should be filed and viewed as UNEXPECTED PROFIT�. Below is an explanation on which property owners are eligible for partial or complete exemption of the capital gains tax.

 

The above numbers are an example of how the calculation would be realized. Tax payers are allowed to apply for exemption or partial exemptions if they fulfill some requirements. These requirements include documentation demonstrating that the owner/seller is selling their main Mexican homestead. Therefore the notary public will require the following documentation from the owner to qualify for any and all exemptions:

 

FIRST

The Notary Public will ask for the following documentation to prove main homestead:

1. Official id of the Mexican (Credencial de Elector) Voter Card ID, if non-Mexican see the below section SECOND
2. Utility bills at the address from either Water, Electric, Telephone, or Gas. (one receipt per year, and a receipt per month for the last 6 months)
3. Correspondence on Bank Statements from a Financial Institution (Banks)
4. Bank Statement from a non financial institution credit organizations (Sam�s Club, Sears credit balance reports for example)

SECOND

If the seller is a non-Mexican, the notary public must first show that the seller is a Legal Resident as well as a Fiscal Resident of Mexico.

Notary Public will ask for the following documentation to prove legal residence if non Mexican:

1. FM3 or FM2

Notary Public will ask for the following documentation to prove fiscal residence:

1. RFC Mexican Tax Id Number

THIRD

If the seller has all of the above documentation, then he can proceed to find out which of the following three options qualifies his situation to determine exemption amounts.

 

OPTION A with the above documentation and if the owner of the land has held possession of the property for 5 years or more , 100% exemption can be realized.

 

OPTION B with the above documentation and if the owner of the land has sold a property�

a) With less than 5 years of possession and�.
b) It is the seller�s first and only sale within one calendar year and�.
c) The property is less than 1,500,000 U.D.I. (approximately $550,000 usd)

The seller can be exempt from 100% of the capital gains tax.

(UDI, is a Mexican inflationary factor that is published on a monthly basis on a federal level. Currently the UDI is 3.08555)

 

OPTION C with the above documentation and if the owner of the land has sold a property�
a) With less than 5 years of possession and�.
b) It is the seller�s first and only sale within one calendar year and�.
c) The property is more than 1,500,000 U.D.I. (approximately $550,000 usd)

 

The seller can be PARTIALLY exempt from capital gains tax.

(UDI, is a Mexican inflationary factor that is published on a monthly basis on a federal level. Currently the UDI is 3.08555)

 

The partial exemption calculation will be further explained in a follow up article regarding capital gains tax themes. But on average, the partial tax due will be an approximate 10% up to 17% versus the 28% maximum rate due depending on the total profit.

 

With a simple applied strategy of obtaining and filing certain receipts, your investment in a second home in Mexico can be very lucrative and profitable. Many foreigners are surprised to find how extremely affordable Mexican properties are (especially waterfront properties) compared with Canadian and USA counter parts. Along with great savings in the cost of acquisition, foreigners are also extremely surprised with the costs of living (annual property taxes, insurance expenses, basic living expenses) in this southern country.

These are major reasons why we have been experiencing an exodus of buyers investing to Mexico from USA and Canada over the past 3 years.

 

Sincerely

 

Thomas L. Lloyd

April, 2007