Separating Fact from Fiction in Mexican Real Estates
WHAT IS MANIFESTING?
Manifesting is simply recording the amount of money spent on a home’s construction or remodel, in order to add it to the Owners cost basis. Adding to your cost basis is the key to reducing your capital gains tax. Proper documentation and manifesting your construction are vital to 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 started 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 of your receipts, cancelled checks and bank statements will not help unless you have completed your manifestation. Before you begin construction, decide how to structure your financial arrangements with your contractor. The two main choices are Cost Plus and a Fixed Bid.
With a Cost Plus contract, the Owner pays the contractor for the cost of materials, plus a fee of 12 to 20 percent. Using this method, it is necessary to keep excellent records in order to prove all expenses. Each time you pay the contractor, he must provide you with a legal Mexican invoice called a factura. Each factura must be in the name of the Beneficiary named in the trust and will include a 15% sales tax in Jalisco and most states (except Baja and Quintana Roo) without factura; nothing you spend is tax deductible as an expense; in Mexico. Also with cost plus you (not the contractor) are responsible for paying the social security tax for each person that worked in your home.
With a Bid contract, the contractor quotes you a flat fee to build your home. A fixed bid includes all labor, materials, Social Security, etc. It is all-inclusive. When using the Fixed Bid process, the burden of record keeping is on the contractor, and you do not have to pay the 15 percent IVA sales tax each time you make a payment. It is, however, still necessary to receive a factura (Mexican invoice) from the contractor for each payment. The factura should reflect the amount of the payment due sans the IVA sales tax. Mexican tax law estates there is no IVA for the construction of a personal residence provided the contractors 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 burden on the contractor.
When using Fixed Bid, make certain the contractor is in agreement to provide you with a factura. Remember to 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 finish construction. The permit is pulled from the Departamento de Obras Públicas, the government Public Works office. Normally, the contractor will pull this permit. Be advised that there are two things you need to watch for:
- Make sure the building permit is pulled in the same name as the Beneficiary named in your trust.
- Make sure the building permit represents the approximate amount of the construction the contractor has quoted.
The fee for the building permit is based on the estimated value of your construction. In an 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 that your cost basis will be accurate for capital gains.
Never report a lower construction value to save some money on the permit fee – it will cost you much more in the long run.
The following is an overview regarding the manifestation regulations currently in place for individuals. Please note that the information is intended for individuals, not corporations. 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 Mexican Notario.
LETTER OF COMPLETION OF WORKS
When construction is finished and you are ready to manifest your construction, you will need to take your building permit to the Departamento de Obras Publicas (Public Works) with a letter stating the total amount you spent on your construction and confirmation that construction and confirmation is finished. You or your contractor can write the letter. With this letter, you will request an official statement of completion called an Aviso de Terminacion de Obra, which is a “Letter of completion 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.
Social Security is a very serious issue in Mexico. A lien can be placed in your home and sold to force payment if taxes are not paid. Beware; this can happen even years after you finish your construction. If the amount of Social Security taxes paid corresponds to the amount of your construction, you will receive a letter from Social Security called Carta de Razonabilidad de Pago, which means “Letter of Reasonability of Payment.” This letter is very important and should be saved as it is your protection to prevent any future claims for non – payment of Social Security taxes. Before you can receive your letter of completion of Works, you will be required to have this Letter from Social Security.
The Letter of completion of Works is the document that actually establishes your construction cost basis for the tax office, should be saved with Fideicomiso (trust) documents.
MANIFESTING YOUR CONSTRUCTION
Once you have your Letter of completion of Works and your letter from Social Security, you simply take them to the tax office (Oficina de Catastro). There, the value will be recorded and added 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 you 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 inaccurately low number will cost you much more in the long run. Pacific Estates International will work with you to make certain that all your documents are in order and that you actual costs are recorded properly. Just as there are no shortcuts or legal ways around taxes in the U.S. or Canada, there are no shortcuts around taxes in Mexico.
Your home is a costly 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” then beware. Seek another agent or broker.
Always get your trust
Always record the real value of your purchase
Always purchase U.S. Title Insurance
Always manifest your construction
If you are considering a real estate purchase in Mexico, make certain everything is done right. Allow Pacific Estates International to put our knowledge and experience to work for you. We are an independent brokerage, assuring our only interest is representing you in a safe, solid and secure real estate transaction.