Capital Gains Tax: Considerations and How to Pay It

During the last edition of Vallarta Real Estate Guide, the topic “Properties in Mexico: Taxes for Foreigners” was addressed, where Jorge Cadena, certified public accountant and partner of the firm Terán Rojas & Associates, explained in detail the different taxes that must be paid by non-citizens who have a residence in our destination.

Situations that foreigners must prepare for when paying and/or calculating this tax.

In that same conversation, our expert mentioned that one of the most misunderstood concepts with the process of buying and selling real estate is concerning the Capital Gains Tax and when it applies and to whom.

“If a foreigner buys a property as an investment to sell it in the near future, a tax must be paid on the profit of that sale. This assessment is known as Capital Gains Tax,” explains Cadena. Similar tax apples in the United States and Canada, but subtle nuances in how the tax is calculated can apply.

From this point on, if a property is initially purchased as a residential residence, what happens when I sell it? “First of all, I highly recommend that the interested party be accompanied by his lawyer and his tax advisor, in this way it will be easier to approach this process” says Cadena. “The second step is to verify whether or not there was a profit. There are several ways to document the purchase price paid—the acquisition cost of the property—to reduce the income from the sale.”

Cadena mentions that, often, there is the erroneous belief that, when a property is acquired in our country, only the deed is enough to support or demonstrate the acquisition cost. “However, as of 2014, in Mexico it was established that, for tax purposes, a document called CFDI (Digital Tax Receipt) or electronic invoice is issued.”

CFDI: What Does it Represent?

When buying a property, you should be sure to obtain a deed to show who is the legal owner. Similarly, for tax purposes, you must have a CFDI that guarantees the acquisition investment made. Not obtaining this document could be a costly mistake down the road.

“Unfortunately, I have come across foreigners who, when buying a property, do not request the CFDI. The problem here originates when they want to sell their residence, because, for example, if they initially acquired it for 500,000 USD and, as the years go by, their capital gain increases, they can sell the property for 800,000 USD. This is a big difference, resulting in a profit of 300,000 USD, on which the Capital Gain Tax should be paid. However, if those 500,000 USD that were initially paid were not guaranteed with a CFDI, then they will not be deductible from the sale amount. That means that, instead of calculating capital gains on the true profit of 300,000 USD, the entire 800,000 USD is subject to taxation. And paying a tax on that amount is going to be very high.”

All real estate activities need to be supported by a CFDI, including the broker’s commission (both in the purchase and in the sale), the notarial expenses and the closing costs, among others.

Globally, Mexico is one of the few countries that uses the CFDI, which means a more sophisticated electronic documentation of the real estate transaction. In the United States and Canada, this form of documentation does not exist.

In addition to the CFDI, Cadena mentions that renovations and improvements made to the property should be considered. “Many foreigners invest in renovations to their residences, which are not usually documented by a CFDI, since their long-term plan is to stay permanently in that place. However, a situation may arise that prompts them to sell it. If there are no invoices, those renovations that improved the property, and therefore increased its value, cannot be deducted.”

Currently, there is an alternative solution for this type of problem: “If you do not have electronic invoices that verify the improvements made, the most advisable thing is to carry out an appraisal of the property, at your own expense. This will demonstrate the current value after improvements and before the sale to decrease the base. This is a strategy that many notaries public and some tax advisers suggest to our clients who are selling their property, to try to reduce the Capital Gains Tax,” Cadena concludes.

As a foreigner, there are two mechanisms to pay the Capital Gains Tax: Pay 25 percent of the gross income from the sale (which is very high) or pay it based on profit, which may have to be requested from a notary.