NELSON'S US EXPATRIATE INCOME TAX SERIVCE

  •  INFORMATION ON FILING FORM 5471 WHEN YOU OWN A FOREIGN CORPORATION
  • MEXICAN CAPITAL GAINS TAXES ON THE SALE OF REAL ESTATE IN MEXICO

IRS FILING REQUIREMENTS WHEN A U.S. CITIZEN OR EXPATRIATE OWNS ALL OR PART OF A FOREIGN (OFFSHORE CORPORATION)

By Don D. Nelson, Attorney at Law, C.P.A.

When the IRS audits your tax return, and tries to collect taxes by disallowing deductions or tries to impose an obscure provision from the tax laws, you can often argue the facts  or the interpretation of the tax law.  But, when you fail to include a required tax form with your US income tax return, there is little left to argue about.  And if the tax law states that failure to file that Form, automatically subjects you to a penalty of $10,000, you are in serious trouble.   This is an IRS agent's  dream.  It's form 5471.

If you own more than 10% of the shares of a foreign corporation, you are required to file form 5471 each year with your income tax return.   That includes any Foreign corporation that operates your business or owns real property.  If  US citizens  own over 50% of a Foreign corporation and you are at least a 10% shareholder there is a good chance you should include your pro-rata share of the foreign corporation's income  in your US tax return. 

The instructions to Form 5471 state that it could take over 32 hours to complete this form.  The form requires that you supply the IRS with the corporation's income statement, balance sheet, and data on its loans, operations and other shareholders.  It also requires information on dividends and managerial payments made to shareholders, officers and directors.

The financial information must be presented using US accounting principles which differ from those used to produce Mexican financial statements.

If you have failed to file the Form, you can avoid the penalty by showing your failure to file was due to "reasonable cause."  The definition of this term is not clear unfortunately.

If you own part or all of a Foreign corporation, and have not filed  form 5471, you should start filing it immediately to avoid the $10,000 penalty.  Though in the past it has been difficult to secure ownership information on Foreign corporations, in the future it will become easier. The IRS is actively involved in securing more information of US citizens finances overseas, and will only increase its efforts in the future.  And, of course, there are many US-Foreign Country  tax treaties which do provide for complete cooperation between the two nations with respect to the exchange of tax information on citizens domiciled in each.

 

HOW THE MEXICAN CAPITAL GAIN TAXES WORK ON THE SALE OF REAL ESTATE IN MEXICO

[Excerpted from an Article by Linda Neil with Mario Valdez published in the Gringo Gazette on February 26, 2001)

Note: This article is currently being revised and is not totally correct. Due to recent Mexican tax law changes it is now possible to sell your personal residence  in Mexico tax free under Mexican tax law.

 

In Mexico when you sell your real estate by selling your trust (fideicomiso) rights you must pay taxes on your profits to the S.A.T. (previously known as the Hacienda) which is the Mexican IRS.  In order to pay the least amount of taxes careful attention must be paid to structuring the purchase and sale. You should always obtain professional advice from a knowledgeable Mexican tax expert.
 

Assuming John and Mary Smith came to Los Cabos and purchased a condominium in 1998 and paid $75,000US in cash plus notary fees, bank fees, etc. of $5,000US.  The Smiths decided to sell in March of 2001 for $75,000US. They are sure there will be no capital gains on the sale because they made no profit. Wrong!
 

In reviewing their purchase deed it is discovered the declared  value of  their purchase transaction price was $30,000US which was the appraised value in 1998. Therefore, their cost basis for tax purposes is $30,000US and not the $75,000US they paid for the condominium. At the time of the sale March, 2001, the appraised value is $60,000US.  However, the law states the amount to be reported  as the sales price is the higher of (1) current appraisal value, (2) property tax value, or (3) current selling price. Therefore they must report the $75,000 as sales price.

 

All buyers should insist their purchases be reported a full sales price, regardless of the fact they may have to pay a higher 2% acquisition fee. Later on sale that additional acquisition fee will not seem as important.  The Smiths in the above example now have a taxable gain of $45,000US regardless of the fact they are selling the property for the same amount they purchased it for.  The capital gains tax which must be paid on sale is paid on the lower of  20% of the gross purchase price or 40% of the difference between the sellers original declared value (adjusted for depreciation and inflation)  plus commissions, sales expenses, and IVA (sales tax) and the selling price. This means that in the situation described above with commissions, IVA, etc.

 

With a normal ten percent commission, this means the Smiths will have to pay a capital gains tax of approximately $7,895US even though they made no profit.

 

It is important that a memorandum be made in the original deed of the purchase price in US dollars. If the purchase price is recorded in pesos, a seller could be hit with additional taxes due to the devaluation of the peso.

 

Mexican citizens or permanent residents who are selling their primary residence were permitted an exemption from the capital gains tax  if they have lived in the residence for two years. In 2002 the law was amended to eliminate the 2 year holding period so long as you can prove the property you are selling is your primary residence and you live in Mexico full time. Many notaries and accountants have tried to obtain this exemption for foreigners who are Mexican residents and can prove they lived continuously in the house for 2 years.  The tax authorities currently are denying this exemption to any property held in a fideicomiso (required method of holding title when foreigners own Mexican property in the "restricted zone" close to the ocean. It would seem this would violate the equal protection laws under the Mexican constitution. This can only be clarified by further legislation or clarification by the Courts.
 

Published with the permission of the Gringo Gazette.
 

 

 

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Don D. Nelson,  US  INTERNATIONAL & EXPATRIATE TAX Attorney
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