Tax Implications of Owning Property in Mexico

Owning property in Mexico as a United States citizen offers many benefits, but it also introduces specific tax obligations in both countries. The legal and financial responsibilities extend beyond the initial purchase, encompassing annual holding costs, income generated from the property, and the eventual sale or transfer to heirs. Navigating these requirements involves understanding distinct tax systems and how they interact.

Taxes Upon Acquiring Mexican Property

The first tax encountered when purchasing real estate in Mexico is the Property Acquisition Tax, known as Impuesto Sobre Adquisición de Inmuebles (ISAI). This is a one-time transactional tax levied by the state or municipality where the property is located, and the buyer is responsible for payment. The rate for the ISAI is not uniform, fluctuating between 2% and 5% of the property’s value.

The calculation basis for this tax is the highest of three possible valuations: the final sale price, the official government-assessed value known as the valor catastral, or a new appraisal value. The Notary Public (Notario Público), who handles real estate transactions, calculates the precise amount due, collects the funds from the buyer, and remits the payment to the government.

Annual Property Taxes and Holding Costs

Once ownership is established, the most direct equivalent to U.S. property taxes is the annual Predial tax. This municipal tax is based on the property’s assessed value and is generally much lower than what property owners are accustomed to in the United States. Municipalities issue Predial bills at the beginning of the calendar year, and many local governments offer discounts between 10% and 20% to owners who pay the full annual amount early, usually within January or February.

For foreigners who own property within the “restricted zone”—defined as land within 50 kilometers of the coast or 100 kilometers of an international border—an additional holding cost is the annual bank trust fee. This arrangement, known as a fideicomiso, is a legal necessity where a Mexican bank holds the official title on behalf of the foreign beneficiary. While not a tax, the annual fee paid to the trustee bank is a mandatory expense for maintaining legal ownership, typically ranging from $400 to $1,000 per year.

Taxation of Rental Income

Generating rental income from a Mexican property creates tax obligations in both Mexico and the United States. In Mexico, foreign owners must register with the tax authority (SAT) and pay income tax, or Impuesto Sobre la Renta (ISR). The tax law provides two distinct methods for calculating this liability.

The first option allows for the deduction of itemized expenses from the gross rental income, which can include costs like Predial taxes, maintenance, and insurance. A requirement for this method is that every claimed deduction must be supported by an official electronic invoice, known as a factura. The second method is a simplified “blind deduction” or deducción ciega, which allows a flat 35% deduction from gross rental income without needing facturas.

For non-residents who choose not to register with the SAT, the tax is a flat 25% withholding on the gross rental income, with no deductions allowed. Simultaneously, U.S. citizens must report their worldwide income to the IRS, which includes all rental income earned from their Mexican property. This income is reported on Schedule E of Form 1040, with all figures converted to U.S. dollars.

To prevent double taxation, the U.S. tax code provides the Foreign Tax Credit. The Mexican income taxes paid on the rental income can be claimed as a credit against the U.S. tax liability on that same income. Taxpayers must file Form 1116 with their U.S. tax return to claim this benefit, which directly reduces the U.S. tax bill.

Capital Gains Tax on a Property Sale

When a U.S. citizen sells a property in Mexico, the profit from the sale is subject to a capital gains tax, also referred to as ISR. The tax is calculated on the gain, which is the difference between the official sale price and the seller’s cost basis. The cost basis is not merely the original purchase price; it can be adjusted upward to account for inflation, initial closing costs, and the cost of any significant capital improvements.

To include capital improvements in the cost basis, the owner must have official facturas for the work performed. The Notary Public overseeing the sale is responsible for calculating the capital gains tax owed and withholding it from the seller’s proceeds. For non-residents, the tax can be calculated as either 25% of the gross sale price or up to 35% of the net gain.

Mexico’s tax law provides an exemption from this capital gains tax if the property was the seller’s primary residence. To qualify for this exemption, which can only be claimed once every three years, the seller must be a tax resident of Mexico with a Mexican tax ID (Registro Federal de Contribuyentes, or RFC). The seller must also provide evidence that the property was their principal home, using utility bills or bank statements issued in their name.

The capital gain from the sale must also be reported to the IRS on Schedule D. The gain is calculated in U.S. dollars, meaning currency fluctuations can impact the size of the taxable gain. The capital gains taxes paid in Mexico can be claimed as a foreign tax credit on the U.S. return, offsetting the U.S. tax liability on the sale.

Estate Planning and Inheritance Taxes

The transfer of Mexican property upon an owner’s death involves considerations in both countries. While Mexico does not have a federal estate or inheritance tax, a 25% tax can be levied on the value of inherited real estate if an heir is not a tax resident of Mexico. An exemption from this tax is often available for close relatives, such as a spouse or direct-line descendants.

For properties held in a fideicomiso, the inheritance process is managed directly through the trust agreement. When establishing the trust, the owner names successor beneficiaries within the document. This designation allows the property to be transferred to the heirs outside of the formal Mexican probate court system, which can be a time-consuming process.

Upon the owner’s death, the beneficiaries work with the trustee bank and a Notary Public to have the title formally transferred into a new or existing trust. While there is no inheritance tax, there are administrative costs associated with the transfer, including fees for the Notary and the bank.

U.S. citizens must remember that their worldwide assets are subject to U.S. federal estate tax rules. The value of the Mexican property must be included in the calculation of their gross estate. It is subject to U.S. filing requirements and potential taxation, depending on the total value of the estate.