REAL ESTATE INVESTMENTS IN BAJA, MEXICO
Mexico offers foreign investors an attractive investment opportunity in an economy that is undergoing dramatic improvement and growth. Following the country’s inability in 1982 to service its escalating foreign debt, Mexico introduced structural changes in its economy designed to move the country toward an open economy with more direct foreign investment. Among the most significant changes were (1) Mexico’s accession to the General Agreement on Tariffs and Trade, (2) a government willing to work with the International Monetary Fund and other sources to restructure the country’s foreign debt, (3) the liberalization of policies concerning foreign ownership of Mexican companies, and (4) the encouragement of tourism development.
In an effort to promote foreign investment, including investment in real estate, Mexico enacted new regulations designed to relax the restriction on foreign investment, which formerly limited foreign ownership of Mexican companies to 49 percent. Under the new regulations, foreign investor’s can now own up to 100 percent of a large number of enterprises, including hotel companies, development companies, etc. without prior authorization from the Foreign Investment Commission. Thus, foreign investors in these enterprises have been put on equal footing with local investors and are no longer required to engage a Mexican investment partner.
The Mexican Federal Corporate Income Tax ranges from 25 to 38 percent. Provisions in the income tax code have also been established to offset the detrimental effects of inflation on monetary assets and liabilities, inventories and depreciable assets.
Mexico will continue to offer foreign investors close proximity to the world’s largest market, a solid communications infrastructure, ample supplies of energy, low labor costs, and skilled and trainable labor resources. The liberalization of the foreign investment rules is a clear indication of the very favorable attitude the government has taken towards foreign investment. The combination of a rapidly improving economy and stable profitable base foretell and excellent ongoing investment environment.
The Mexican government has stated that it aims to double the number of foreign tourist arrivals into Mexico, representing foreign exchange revenue of $5 billion plus annually. A key to achieving the government’s goal of ten million visitors a year is to develop new tourist destinations with modern facilities and infrastructure. The Los Cabos region is a priority area for this targeted growth.
MEXICAN PROPERTY TRUSTS (FIDEICOMISO)
Foreign citizens who wish to buy property within designated regions of Mexico are required to obtain a “Fideicomiso” (fee-day-co-me-so), which functions as a Mexican Property Trust.
In 1994, amendments to the Constitution permitted foreigners to purchase and own real estate in Mexico located within the “restricted zone” which is all land within 60 miles of a national border and within 30 miles of the Mexican Coast, which includes all real estate in Los Cabos. This Law permitted ownership through a property trust or “Fideicomiso”.
The way the Fideicomiso works is the Mexican Government issues a permit to a Mexican Bank of your choice, allowing the bank to act as purchaser for the property. The bank acts as the “Trustee” for the Trust and you are the “Beneficiary” of the Trust. The “Beneficiary” rights are very similar to Living Wills or Estate Trusts in the U.S.
The bank, as trustee, takes instructions only from the beneficiary of the trust (the foreign purchaser). The beneficiary has the right to use, occupy and possess the property, including the right to build on it or otherwise improve it. The beneficiary may also sell the rights and instruct the trustee to transfer title to a qualified owner.
Many people refer to the trust arrangement in Mexico as a lease agreement… this is not true. The home or property that you buy will be put into a trust with you named as the beneficiary of the trust – you are not a lessee. You have all the rights that an owner of property in the U.S. or Canada has, including the right to enjoy the property, sell the property, rent the property, improve the property, etc.
The initial term of the trust is 50 years. An investor can renew the trust for an additional period of 50 years within the last year of each 50-year period, and this process can be continued indefinitely, providing for long-term control of the asset.
CAPITAL GAINS IN MEXICO
Capital Gains Tax
Capital gains tax law in Mexico states that tax is owed on the profit you receive when you sell your home or property. By law, you have two options when it comes to capital gains and you can use whichever is the better of the two options for you:
1. You pay 28 percent* of the net profit. (There are a variety of deductions included in this option.)
2. You pay 25 percent* of the gross sales amount with no deductions.
Although a 28 percent capital gains tax may seem high, Mexico does have several laws and procedures that will assist you in maximizing your cost basis, thereby reducing your net profit and lowering your capital gains. The key is to understand these laws before you buy, not when you decide to sell.
*Percentages reflect the 2007 Tax Code.
Always record your true Purchase Price at closing.
In the past, some real estate companies have recorded values lower than the actual purchase price in an effort to “save” taxes for their client; they thought they could save money on the two percent acquisition tax. This is a major error. Never record a lower value than what you actually paid for the property. Doing so simply establishes a lower cost basis for the property, which increases your capital gains tax liability. The first step in calculating your capital gains is to subtract the value you have recorded in your trust, or Fideicomiso (fee-day-co-me-so), from the sale price of your property.
An oversimplified example is: You wisely purchase a home site (lot) for $1 million, but unwisely record a value of $500,000. In the eyes of Mexican tax law, your cost basis is now $500,000. If you sell the lot for $1.2 million, you see a profit of $200,000. However, according to your recorded cost basis, Mexico sees a profit of $700,000 and your capital gains tax for Mexico will be 28 percent of $700,000 ($196,000) — a difference of $140,000 in profit. Engel & Völkers Snell Real Estate’s approach to ownership in Mexico, specifically the trust process, has been established to protect you and provide you with the legal means to safeguard your investment. Recording your authentic purchase price with proper documentation is the only way to maximize your potential profits. The bottom line is to always secure your property trust for the true value of your purchase as quickly as possible.
Never allow anyone to convince you to record a lower value than what you have actually paid for your property, or you will assume the Seller’s capital gains tax liability. Recording a lower value today can cost you, should you decide to sell in the coming years. If a Seller can convince a Purchaser to record a lower value, the tax liability is simply passed along, and eventually someone will have to pay. Don’t let anyone tell you, “That’s how we do it here.” Mexico is like everywhere else — the capital gains tax is the responsibility of the Seller.
Fact: Recording a property’s true value benefits you and establishes your cost basis in the eyes of Mexico.
Fact: The amount you pay for a property has no impact on your yearly property taxes.
Fact: Capital gains taxes you pay in Mexico can be applied to your U.S. taxes.
How do I know if my value is recorded correctly?
Engel & Völkers Snell Real Estate’s closing officer oversees the creation and completion of your trust. We review the documents with you to make certain everything is in order, and we are present when you sign your trust. You can verify the value yourself by examining your trust and noting the amount written in text, which is indicated in U.S. dollars or Mexican pesos and includes the exchange rate of that day. (We will provide a certified translation of your Spanish trust.) Simply divide the current exchange rate into the peso amount and make sure the result reflects the actual dollar amount you have paid. If you would like to review an old trust, simply determine the peso rate for the day and year the trust was executed. We can assist you in finding the exchange rate, as can the bank and the Internet.
What is inflationary credit?
As soon as you pay your two percent acquisition tax to receive your trust, you are eligible to receive an inflationary credit from the Mexican government for each year you own the property. This credit is added to your cost basis when you decide to sell your property. The credit is based on consumer index adjustments (inflation) and can be quite significant. In the past when inflation was higher, we have seen credits in excess of 15 percent per year applied to a cost basis when you acquired your property some years ago. On a million-dollar property, this can be as much as $150,000 USD per year added to your cost basis, significantly reducing your capital gains tax should you decide to sell in the coming years.
Fact: You are not eligible to receive the inflationary credit unless you have paid your two percent acquisition tax.
What about the primary residence capital gains exclusion?
Mexico, as well as the U.S., provides its residents a capital gains tax incentive for their primary home. The tax incentive in Mexico states that if you sell your “primary residence,” you pay no capital gains. This law is in place for “residents” (Mexican nationals or foreigners) of Mexico only, and there are several items required to establish residency status. In order to claim your home as your primary residence in Mexico, you must be able to prove that it really was your primary residence for a period of five years. At closing, you will be required to provide the Notary with a residence visa or working permit (FM2), as well as a bank account, water, phone and electric bills, paid tax receipts and your Trust — all in your name, all with the address of the home, and all in place for more than five years. In some circumstances, a tax ID number may be necessary. Please keep in mind that this is just a guideline of the requirements. It is necessary to communicate with the Notary prior to closing your transaction in order to know if you are eligible for exemption.
*Based on the 2007 Tax Code.
Fact: You cannot have two primary residences at the same time. Therefore, if you claim the home in Mexico as your primary residence, you give up your primary residency status in the U.S.
Fact: The capital gains tax exclusion is intended for residents of Mexico, not for persons owning second homes or vacation homes.
Just as there are no shortcuts or legal ways around taxes in the U.S. or Canada, there are no shortcuts around taxes in Mexico. Your home is a sizable investment and following proper legal steps will ensure a safe and enjoyable experience in Mexico. If someone says, “This is Mexico, and that’s the way we do it here,” then beware. Seek another agent or Broker. If you plan on building a home or doing a major remodel to an existing home, please read the next section, “Manifesting Your Construction,” to make certain all your expenses are added to your cost basis. If you are considering a real estate purchase in Baja, make certain everything is done right. Allow Engel & Völkers Snell Real Estate to put our knowledge and experience to work for you. We are an independent brokerage, assuring our only interest is representing you in a safe, solid and secure real estate transaction.
Helpful Hint: When you sign your new trust, ask the Notary to jot down the exchange rate on the document itself. This will be useful in the future.
MANIFESTING YOUR CONSTRUCTION
What is manifesting?
Manifesting is simply recording the amount of money spent on a home’s construction or remodel, in order to add it to the Owners’ cost basis. Adding to your cost basis is the key to reducing your capital gains tax. Proper documentation and manifesting your construction are vital to building your new home.
Why do I need to manifest my construction?
When you sell your home, the manifested cost plus the cost of your lot stated in your trust (title), will be used to determine the basis for capital gains tax. If you have not manifested your construction, Mexican tax law will not recognize your construction costs and you will not be able to use them as a deductible expense. All of your receipts, cancelled checks and bank statements will not help unless you have completed your manifestation. Before you begin construction, decide how to structure your financial arrangements with your contractor. The two main choices are Cost Plus and a Fixed Bid.
Pulling a Building Permit
The building permit is the first step to manifesting your property correctly. You will need the permit both to start construction and finish construction. The permit is pulled from the “Departamento de Obras Publicas,” the government Public Works office. Normally, the contractor will pull this permit. Be advised that there are two things you need to watch for:
1. Make sure the building permit is pulled in the same name as the Beneficiary named in your trust.
2. Make sure the building permit represents the approximate amount of the construction the contractor has quoted.
The fee for the building permit is based on the estimated value of your construction. In an effort to reduce this fee, some contractors will report a lower construction amount when pulling the permit. This is a huge mistake. You want your construction costs recorded accurately so that your cost basis will be accurate for capital gains.
Helpful Hint: When using Fixed Bid, make certain the contractor is in agreement to provide you with a factura with no 11 percent sales tax added for each payment. Remember to have this in writing in your construction contract.
Helpful Hint: Never report a lower construction value to save some money on the permit fee — it will cost you much more in the long run.
Letter of Termination of Works
When construction is finished and you are ready to manifest your construction, you will need to take your building permit to the Departamento de Obras Publicas (Public Works) with a letter stating the total amount you spent on your construction and confirmation that construction is finished. You or your contractor can write the letter. With this letter, you will request an official statement of completion called an “aviso de terminación de obra,” which is a “Letter of Termination of Works.” This letter will state the amount you spent on your construction, which should be in accordance with the amount stated on the building permit.
Social Security is a very serious issue in Mexico. Your home can actually be liened or sold to force payment if taxes are not paid. Beware, this can happen even years after you finish your construction. If the amount of Social Security taxes paid corresponds to the amount of your construction, you will receive a letter from Social Security called “Carta de Razonabilidad de Pago,” which means “Letter of Reasonability of Payment.” This letter is very important, as it is your protection to prevent any future claims for non-payment of Social Security taxes. Before you can receive your Letter of Termination of Works, you will be required to have this letter from Social Security
Manifesting your construction
Once you have your Letter of Termination of Works and your letter from Social Security, you simply take them to the tax office (Oficina de Catastro). There, the value will be recorded and added to the cost reflected on your trust document. Once completed, you have successfully manifested your construction and established an accurate tax basis for your property.
Fact: If you do not have a trust, you should not begin construction. Without the trust document you cannot pull a building permit in your name and you run the risk of not being allowed to deduct your land cost or construction cost when you sell.
Fact: Annual property taxes are relatively low in Mexico, but capital gains taxes are not. Registering an inaccurately low number will cost you much more in the long run. Engel & Völkers Snell Real Estate will work with you to make certain that all your documents are in order and that your actual costs are recorded properly. Just as there are no shortcuts or legal ways around taxes in the U.S. or Canada, there are no shortcuts around taxes in Mexico. Your home is a costly investment and following proper legal steps will ensure a safe and enjoyable experience in Mexico. If someone says, “This is Mexico, and that’s the way we do it here,” then beware. Seek another agent or broker.
• Always get your trust.
• Always record the real value of your purchase.
• Always manifest your construction.
If you are considering a real estate purchase in Baja, make certain everything is done right. Allow Engel & Völkers Snell Real Estate to put our knowledge and experience to work for you. We are an independent brokerage, assuring our only interest is representing you in a safe, solid and secure real estate transaction.
IMPORTANT: The Letter of Termination of Works is the document that actually establishes your construction cost basis for the tax office.
THE HISTORY OF MEXICAN LAND
To fully understand how land ownership in Mexico works, it is vital to learn the history of property ownership in Mexico. If you picture a country that has been dominated by foreign owners since the early 1500’s, you will begin to see why Mexico is so protective of its most valuable resource…land.
In 1517, when Hernandez de Cordoba sailed from Spain to the Yucatan Peninsula, foreigners laid claim to Mexican lands. Spain decided that since they had landed here, it was now theirs. It was not until 1822 that Mexico declared its independence from Spain, much like the U.S. declared independence from England, but even with this new independence, the lands of Mexico were still owned by wealthy foreigners, the Mexican upper class and the Church. Porfirio Diaz, a former President of Mexico for over 30 years, nearly sold all of Mexico to foreigners during his term.
The end result was the Mexican Revolution, which cost over one million lives and was the basis for the Federal Constitution of 1917. The new constitution imposed new laws and restrictions on foreign ownership and ownership of real estate by the Catholic Church. Article 27 of the constitution allows Mexican Nationals and Mexican Companies to own property in Mexico, however it restricts foreigners from owning land with the restricted zone. Foreign citizens must obtain a Fideicomiso, which acts as a bank trust, in order to buy property in Mexico.
It is also said that the U.S. was involved in this new zoning in an effort to prevent the installation of foreign military bases on our borders or near our coastlines. This “restricted zone” is defined as property within 60 miles from any Mexican border or within 30 miles of any Mexican coastline, which includes the real estate in Los Cabos.
Not until the 1930’s did the Mexican people truly see the property being returned to them. President Lazaro Cardenas disassembled the large property holding and distributed them in the form of cooperative farms or “Ejidos”. The people were given ownership of these properties and were allowed to farm and cultivate them and receive the profit from their efforts. After nearly 4000 years, over 50 million acres of land was back in the hands of the Mexican people, however, it was still owned by the Federal Government.
Even though the people were allowed to farm the properties and profit from their work, it was not until 1992 that they were allowed to sell the properties. The 1992 Agrarian Law recognizes property rights within the Ejido and allows for the owner of record to sell or lease the property to a non-Ejido member. The property can be removed from the National Agrarian Registry (removed from Federal Control) and placed in the public land registry allowing it to be sold or leased. Today, thousands of acres are being removed on a daily basis from the Ejidos, added to the public lands and being sold or leased. There are well over 50 million acres of land that will go through this process to be either leased or sold over the coming years, making investing in Mexican real estate an attractive venture for foreign investors.
For more information on investing in real estate in Mexico, please contact us today: