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this series of 4 articles for Americans purchasing real estate in Mexico is reprinted courtesy of Snell Real Estate, Cabo San Lucas, Baja California, BCS, Mexico 12-1-05. Information believed accurate but without any guarantee.

Ownership in Mexico - Separating Fact from Fiction

The "Gunslinger Days" of buying property in Mexico are over. Banking on the words "That's the way we do business here!", and trusting "Thy Seller", have given way to U.S. Title Insurance and bonded escrow accounts.

During the last ten years, property in Mexico has become a lucrative and viable investment strategy, bringing with it a new breed of sophisticated investors. U.S. title insurance, bonded escrow accounts and comprehensive title searches are "in"... promises and handshakes are "out".

Owning property in Mexico is easier and safer than ever, because now there are established and well defined rules regarding non-Mexicans owning land in Mexico. These rules are in place to protect your ownership rights and to promote the sale of real estate to foreign investors. The key is a safe, established and perpetually renewable Mexican Property Trust called a "Fideicomiso".

What is a "Fideicomiso" or Mexican Property Trust?
With the advent of North American Treaty Agreement, the Mexican Government recognized that it was critical to make foreign investment in Mexico safer and easier than ever. Because the Mexican Constitution prohibits foreigners from purchasing or owning real estate within 60 miles of an international border or within 30 miles of the Mexican Coast, a new, safe method of holding title was created. This new instrument, modeled after the one in Monaco, allows ownership through a Mexican Property Trust, called a "Fideicomiso". This is a trust agreement, much like an estate trust, giving you all the rights of ownership.

The Department of Foreign Affairs in Mexico City 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. This is not an asset of the bank; they simply act as the Trustee to hold the Trust.
Much like Living Wills or Estate Trusts in the U.S., the Mexican Bank, or Trustee, takes instructions only from the Beneficiary of the Trust (You). 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 property by instructing the Trustee to transfer the rights to another qualified owner, or bequeath the property to an inheritor. The initial term of the trust is 50 years, and it can be renewed for an additional periods of 50 years indefinitely, providing for long-term control of the asset.
You have all the rights of a property owner in the U.S. or Canada, including the right to enjoy the property, sell the property, rent the property, improve the property, etc. This is not to be confused with a "land lease." The property you buy is placed in a trust with you named as the Beneficiary of the trust - you are not a lessee. If the property you purchase is already held in a Trust, you have the option of assuming that Trust, or having the property vested in a new Trust.

How Long Does It Take To Get A Trust?

At Snell Real Estate, we work with Federal and State Notaries for all our closings, and to secure your new Trust. (In Mexico, a Notario Publico is much different than in the United States, more like a Clerk of Courts.) On average, we can obtain your Trust within 60 days and in some cases, we have actually transferred title in as little as two to three weeks. We oversee the entire process and make certain you understand each and every step involved. We can even provide you with an English sample Trust for you to review.

You would be amazed how many people have only a simple buy/sell agreement between themselves and the seller as evidence of ownership. This is not a safe method of ownership and is not recommended by Snell Real Estate or Stewart Title Guaranty.

Rule Number 1: Always get your Trust.

When Do I Pay For My Property?

When you have clear title, exactly like you would anywhere else. By using our U.S., bonded, third party Escrow service with Stewart Title Guaranty, Houston Texas, your money is held in an individually numbered, bonded and insured escrow account until your Trust is complete and the property rights have been transferred to you.

We do not recommend that you release funds to a seller unless you have received your Trust first. Purchasing property without receiving a Trust is simply buying without receiving the title in your name, which is risky and not recommended.

Fact: Until you have received your Trust, and rights to the property have been transferred to you, the legal owner of record in Mexico is still the previous owner.

Fact: You cannot bypass Mexican Taxes or fees by not getting your Trust, even if you sell the property to someone else before you have your Trust in place.

Do I Need Title Insurance?

Whether you buy real estate in the U.S. or Mexico, Snell Real Estate recommends U.S. Title Insurance for every property you purchase. You have insurance for your car, your home and your health, why not purchase it for one of your largest investments, your property. Snell Real Estate will not represent or sell any property in Mexico that cannot be covered by a U.S. Title insurance policy with Stewart Title Guaranty, Houston Texas.

Fact: U.S. Title Insurance is available for properties in Mexico purchased by U.S. Citizens.

Fact: Just because you have a Trust does not ensure you have free and clear title.
In a Stewart Title property search, the properties title is searched all the way back to the Mexican Revolution. Most title searches to secure a Trust only go back one or two owners of record.

How Can I Own My Property?

In the Trust document, you must name the Beneficiary or foreign owner for the property. This can be you personally, multiple partners, a foreign corporation, an estate trust, a living will, or other entity. The Trustee of the Trust (the Mexican Bank) will take direction from whomever you name as the Beneficiary.

Fact: You can name a U.S. Corporation as the Beneficiary of the Trust. This is perfectly legal.

Fact: If you sell more than 25% of the shares in the U.S. Corporation, you have created a real estate transaction in Mexico, and all Mexican Taxes apply.
(This is Article 151 of the Mexican Revenue Code and is also declared in the International Tax Treaty between the U.S. and Mexico. If this is done, and you do not pay the Mexican Taxes, you will have created a tax burden over the property for the new owner.)

Fact: You can own a property in a Mexican Corporation and take title fee simple only if the property is for development or investment purposes.

Fact: You cannot own property through Mexican Corporation to by-pass the Trust process.

Fact: It is against the law for a foreigner to own property in a Mexican Corporation for residential purposes.
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Capital Gains in Mexico…Separating fact from fiction in Mexican real estate

The information provided here will help you understand the tax system in Mexico and the important issues related to it. Regardless, we recommend you meet with a tax professional prior to completing your purchase to confirm whether any of the laws have changed since this document was published in 2005.

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.

Option 1: 30 percent of the net profit. (There are a variety of deductions included in this option.)
Option 2: 25 percent of the gross sales amount with no deductions.
(Percentages reflect the 2005 Tax Code)

Although a 30 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 thus lowering your capital gains. The key is to understand these laws before you buy, not when you decide to sell.

Why should you take on the seller’s capital gains liability?

The first step in calculating your capital gains is to subtract the value you have recorded in your trust (fideicomiso) from the sales price of your property. In the past, some real estate companies recorded values lower than the actual purchase price in an effort to “save” taxes for their client. They think they can save money on the 2 percent acquisition tax. This is a big mistake. 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.

An oversimplified example is: You wisely purchase a 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 30 percent of $700,000 ($210,000.) You just lost $10,000 instead of making a profit.

Rule Number 1: Always record the full value of your purchase.

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 real purchase price and proper documentation is the only way to maximize your potential profits. The bottom line is to always secure a trust over your property as quickly as possible for the real value of your purchase.

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 get a buyer to record a lower value, the tax liability simply is 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.

It's simple:

1) It isn’t yours until you have the title in your name.
2) If you don’t record the accurate value of your purchase, you’re most likely taking on someone else’s capital gains liability.

Fact: Recording the real 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?
The Snell Real Estate closing department will oversee the creation and completion of your trust. We review the documents with you and, to make certain everything is in order, we are present when you sign your trust.

You can verify the value yourself by examining the first page of the trust document and noting the amount written in text, which is always in Mexican Pesos. 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 want to check 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.

(Helpful hint: When you sign your new trust, ask the Notary to jot down the exchange rate on the document itself. This will come in handy years later.)

What is inflationary credit?
As soon as you pay your 2 percent acquisition tax to receive your trust, you are eligible to receive an inflationary credit from the Mexican Government for every 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. We have seen credits in excess of 15 percent per year applied to a cost basis. On a million-dollar property, this can be as much as $200,000 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 2 percent acquisition tax.

Fact: You can receive the inflationary credit based on the date of your buy/sell agreement, provided you paid the 2 percent acquisition tax for the property.

What about the two-year capital gain exclusion?
Mexico, as well as the United States, 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” after two years, you pay no capital gains. This law is in place for “residents” (Mexicans 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 is your primary residence.

At the closing, you will be required to provide the Notary with a residence visa (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 two years.

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 United States.

Fact: The capital gains tax exclusion is intended for residents of Mexico, not for persons owning second homes or vacation homes.

There are no short cuts and no legal ways around taxes in Mexico any more than there are in the United States or Canada. Your home is a large 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,” they have just thrown up a red flag and you should seek another agent.

If you plan on building a home or doing a major remodel to an existing home, please read our informational brochure, “Manifesting Your Construction,” to make certain all your expenses are added to your cost basis.
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Manifesting Your Construction

Record the cost of your new construction. Receipts alone won’t cut it.

What is manifesting?
Manifesting is simply recording the amount you spend on your construction, or remodel, in order to add it to your cost basis. Adding to your cost basis is the key to reducing your capital gains tax. Proper documentation and manifesting your construction are vital parts of 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 your receipts, cancelled checks and bank statements will not help unless you have completed your manifestation.

Before your begin construction
Decide how to structure your financial arrangements with your contractor. The two main choices are cost plus and a fixed bid.

Cost plus
With cost plus, you pay the contractor for the cost of materials, plus a fee of 12 to 20 percent. Using this method, you will need to keep excellent records in order to prove all your expenses. With cost plus, you (not your contractor) are responsible for paying the Social Security tax for every person working on your home.

Each time you pay the contractor, he must provide you with a legal Mexican invoice called a Factura. Each Factura must be in your name and will include a 10 percent sales tax called IVA. Without the Facturas, nothing you spend is deductible as an expense in Mexico.

Fixed bid
With a fixed-bid contract, the contractor quotes you a flat fee to build your home. A fixed bid will include all labor, materials, Social Security, etc. It is all-inclusive. When using the fixed-bid process, you put the burden of record keeping on the contractor, and you do not have to pay the 10 percent Mexican IVA tax each time you make a payment. You will still need to receive a Factura (Mexican invoice) from the contractor for each payment. However, the Factura should reflect the amount of the payment due with no 10 percent sales tax (IVA tax).

IVA tax is basically a sales tax, and Mexican tax law states there is no IVA tax for the construction of a personal residence, provided the contractor is providing an all-inclusive bid. Again, the fixed-bid process is much less labor-intensive for you and puts the majority of the record keeping on the contractor.

Helpful hint: When using fixed bid, make certain the contractor is in agreement to provide you with a Factura for each payment, with no 10 percent sales tax added. Have this in writing in your construction contract.

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 to finish the construction. The permit is pulled from the government office called Obras Publicas, meaning Public Works. Normally, the contractor will pull this permit, and 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 proposed to do the work.

The fee for the building permit is based on the estimated value of your construction. In and 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 your cost basis will be accurate for capital gains.

Helpful hint: Never report a lower construction value to save some money on the permit fee, because 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 Obras Publicas office with a letter stating the amount you spent and that you have finished your construction. You or your contractor can write the letter. With this letter, you will request an official statement of completion called an "Adviso 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. Important: This letter is the document that actually establishes your construction cost basis for the tax office.

Social Security
Social Security is very serious issue in Mexico, and your home can actually be liened or sold to force payment if these taxes are not paid. This can even happen years after you finish your construction.

When you receive your “letter of termination of works,” Obras Publicas will send a copy to the Social Security office. They will compare this amount with what you or your contractor has paid to Social Security during construction. (If you are using cost plus, you are responsible for paying the taxes; and if you are using fixed bid, the contractor is responsible.)

If the amount of Social Security taxes paid corresponds to the amount of your construction, you will receive a letter from Social Security called a “Carta de Razonabilidad de Pago,” which means a “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.

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, called the Catastro office. They will record the value and add it 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 artificially low number will cost you much, much more in the long run.

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. There are no shortcuts and no legal ways around taxes here, any more than there are in the United States or Canada. Your home is a large 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,” they have just thrown up a red flag and you should seek another contractor.

Always get your trust. Always record the real value of your purchase. Always purchase U.S. title insurance. Always manifest your construction.

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The History of Mexican Land

To really understand how ownership in Mexico works, it is important to understand the history of property ownership and its evolution 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 lands by the Catholic Church. Article 27 of the constitution allows Mexican Nationals and Mexican Companies to own property, however it restricts foreigners from owning land with the restricted zone. 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.

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.

Mexican Property Trusts (Fideicomiso)

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. This Law permitted ownership through a land trust or "Fideicomiso".

A "Fideicomiso" is a Mexican Trust. The way it 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 law authorizes Mexican banking institutions to act as trustees. A 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.

Documentation

Snell Real Estate will facilitate long-term investment by individuals and developer's by listing and offering only properties with all necessary entitlements and approvals. The property purchase procedure will be similar to transactions in the United States. Documentation will be standardized in both English and Spanish, and title insurance will be available on all properties we sell.

Investing in Mexico

Mexico offers the foreign investor 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, 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.