Capital Gains Tax and Construction WRITTEN BY JANET JENSEN ON JAN 24, 2020

So you are thinking about purchasing or selling property in Los Cabos.
Here is an overview of Capital gains and how it affects the sale or purchase of a property in Mexico.

With endless possibilities of great things to do and places to explore – Los Cabos is a great place to live. In 1992, my father and step-mom, purchased a home-site and built a house in San Jose del Cabo. I immediately fell in love with the area, the community and the lifestyle the moment I stepped off the plane from my native Vancouver, British Columbia. Real estate has always been in my family, I’m blessed to be able to sell vacation and resort properties in the Baja.

According to the law in Mexico, tax is owed on the profit received when selling a property. An owner who sells property in Mexico is liable, much like the United States or Canada, for the payment of I.S.R. tax (Impuesto Sobre la Renta), which is the Mexican equivalent of the Capital Gains tax. By law, the tax paid is either -

  1. 25% of the declared value of the transaction (Gross sales price); OR,
  2. 35% of the net gain, less the qualifying improvements made, commissions paid, and any other allowable expenses.

The formula is complicated and the tax should be figured both ways and confirmed by the Notary Public (Notario Publico) who will be involved at closing with the tax declarations. It is the lesser of the two calculations. Your real estate agent’s office can often help with a preliminary estimate; however, consider this is simply a guideline.

The tax is calculated based on your investments, both land acquisition and construction, in Mexican pesos. The purchase price is exchanged into pesos for taxation purposes using the official exchange rate on the date of closing for the acquisition. Construction or remodel investments will be exchanged on the dates either when the official receipts (facturas in Spanish) are issued - should they be paid in US dollars; or, when the investment value will be converted to pesos for the ‘termination of works’ (terminacion de obras in Spanish) and ‘manifestation of construction’, more on these certificates below. The sales price will be converted to pesos on the date of closing of the sale. Exchange rate fluctuations play an important role in taxation.

The only exception is those for who reside in the property as their principle residence – in this case there may be an exemption of up to $5,000,000 MX pesos (approximately equivalent to USD $250,000.00). For this scenario, as a non TAX RESIDENT, the requirements include; having a permanent resident status at immigration, an ‘RFC’ (Mexican Tax ID number), and a ‘CURP’ (personal ID code). At least two receipts for bank statements, telephone and/or electricity in your name (as it appears on title), with your RFC code referenced will also be required. This exemption is only applicable for ‘individuals’, not foreign entities (such as an LLC, corporation or foreign trust).

Mexico has several laws and procedures, which allow one to maximize the cost basis, thereby reducing net profit and potentially lowering capital gains. The key is having an understanding of these laws before you buy, not when you decide to sell. Your local Los Cabos real estate agent and/or their closing officer can help with an introduction and overview.

Manifesting is the recorded amount of money spent on a home’s construction. Accounting for improvements for cost basis is the key to correctly calculating capital gains tax. Proper documentation, such as obtaining a construction license and manifesting your construction, are vital when building a new home or facilitating a remodel in a condominium or home. When remodeling, be sure to collect factura’s from contractors, suppliers and/or materials – these ‘facturas’ must be issued in the name of the title holder(s), and reference the subject property, in order to be accepted as a deduction by a notario. Confirm this information with your contractor, attorney and/or directly with a notario to ensure accuracy.

When selling a property, the manifested cost plus the cost of the lot stated in the trust (title), in pesos, will be used to determine the basis for capital gains tax. If you have not manifested your construction, construction costs (improvements) will not be added to the lot value, you will need to explore alternatives such as a ‘referred appraisal’. Receipts, cancelled checks and/or bank statements may not be used unless the manifestation is completed.

In order to manifest the improvements, the building permit needs to be submitted at the Departamento de Obras Publicas (Public Works) with a letter stating the total amount spent on construction and confirmation the construction is finished. You and/or your contractor can write the letter. This letter is a request for the 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. A reputable builder or contractor will take care of this as part of the construction agreement. After obtaining this letter submit it to the Catastro office to be manifested. When listing a property for sale, your real estate agent will ask for the letter of termination and the manifestation as part of the listing file.

There can be a ‘reverse’ capital gain scenario – This means if you purchase a real estate property for less than 10% of the tax appraised value, as a non tax residents you are subject to a 25% capital gains tax on the difference. A Mexican National or Foreigner but tax resident can also be subject to this tax, however, their rate is 20%. A government appointed appraiser determines the appraised value at the time of sale.

This capital gains information is intended for properties held by individuals or foreign entities, and is not applicable for Mexican companies. Over time these regulations may change, therefore it is important to make sure that the process outlined here is still in effect by contacting a certified accountant or a Mexican Notario.

*Source - 2018 Mexican Tax Code. Check with an Accountant or Notary for any changes in these percentages - all information has been verified by Lic. Javier Mazoy – Lex Advisors January 2020.