Tax rules in the USA for those owning Mexican property

Baja Sur has become one of those Mexican states that attract Americans with their real estate. However, many homeowners find it too perplexing to deal with the IRS and stick to the tax rules in the USA when having some property in Mexico. In this article, we are going to shed some light on all the intricacies of these regulations so that you can benefit from your tax return.

Types of properties and regulations

Primary residence

If your property in Baja Sur is a primary residence, there will be no difference between the tax rules in the USA and those in Mexico. As an owner, you are allowed to reduce taxable income through interest deduction on your $1.1 million mortgage as well as your property taxes. Typically, these deductions are claimed as itemized ones on Schedule A.

According to the tax rules in the USA, you can qualify for exemption when it comes to selling a primary residence. If you own and live in a property for at least 24 months out of the last 5 years, you will be able to get tax relief for up to $500,000 of the amount gained from the sale. Plus, if you meet all Mexican regulations, you may also qualify for exemption from Mexican taxes. To make sure you comply with the Hacienda federal requirements, it’s recommended to ask the advice of a local CPA.

Secondary residence

Regulations on secondary residences in Mexico are identical to the second-home tax rules in the USA. For the properties of this type, homeowners can also claim tax and mortgage interest deductions and itemize them using Schedule A. But note that there are certain limits on the deductible interest amount for first and second mortgages.

Rental property

In Mexico, the Fideicomiso bank trust is mainly used to hold real estate. This trust serves as a fiduciary making sure your rental property taxes are collected just like those covered by the tax rules in the USA. Similar to the latter regulations, Mexican owners have to use Schedule E and pay rental income taxes, which can be offset against the federal debt. Unlike the tax rules in the USA, you have to use a 40-year depreciation period when calculating your deductions.

Commercial property

Commercial property that is located in the Baja Sur restricted zone must be owned through an entity (or a Mexican corporation) if you are a foreigner. This is required by the local law. To comply with it, you also have to report your gains using Form 5471 and Form 926.

In order to be taxed as a flow-through corporation, it’s better to ensure that your entity is a Limited Liability Company, known as a Sociedad de Responsabilidad Limitada in Mexico.

In this case, you will be able to:

  • file the form for foreign tax credits;
  • make use of a rental property loss allowance to pay less in taxes;
  • prevent the amount gained from the sale from being taxed twice when selling the property.

Form 8938 requirements

According to the IRS disclosure regulations and the tax rules in the USA, Baja Sur homeowners do not have to report their property when filing tax returns. This applies to the cases when real estate is held directly on homeowners’ behalf or in the Fideicomiso. However, filing Form 8938 is a must if the property is held by a foreign entity.

Foreign financial accounts

If you have a bank account in Mexico, you may be required to report it as stated in the IRS tax rules in the USA. It is a must only if the combined balance of all your foreign accounts exceeds $10,000. For reporting, taxpayers have to use Form 114.

Hope this information will come in useful for you!