Over the past several years that I have worked in the Real Estate industry, here in the Greater Puerto Vallarta area of Mexico, I have many times come across sellers who are selling a home that they have purchased, already built, but their Escritura or Fideicomiso reflected that they only purchased a lot and not a house. (Yes, this was most likely done by either a lazy or corrupt attorney or even the Notary and in order to save the original seller a great deal of taxes) This has ended up costing them a great deal of money to properly “Manifest the Construction” of the house onto their deed, or they would be paying an unfair and high amount of Capital Gains Tax, up to 35%. It also has caused several sales to collapse due to the time it can take to get this task done.
In this article, you will see many references to receiving a factura for both the material and labour costs. For you to receive a factura in your name, you must have an RFC or CONSTANCIA DE SITUACION FISCAL this is your Mexican Tax ID, the same as a SSN or SIN in the US or Canada.
Today, in order for you to have an RFC, you must either a Mexican Citizen, a Permanent Resident or a Temporary Resident with Permission to Work.
Recording the Cost of Your New Construction
What is manifesting?
Manifesting is simply recording the amount you spent on your construction, or remodel, in order to add this to your cost basis. Adding to your cost basis is the key to reducing your Capital Gains Tax. Proper documentation and Manifesting Your Construction is a vital part of building your new home. This is something that should be done as soon as you finish with all of the construction and close out the permits. Do not wait until you place your home up for sale, as this process has been known to take anywhere between 3 to 6 months, depending upon the Municipal Office, the amount of work done, as well as the Contractors you worked with and whether they had all of their own paperwork in order, purchased all of the material with Facturas and their employees were all properly registered.
Why do I need to manifest my construction?
When you sell your home, the Manifested cost plus the cost of your lot stated 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 your receipts, cancelled checks and bank statements will not help, unless you have completed your Manifestation.
Before Your Begin Construction…
Decide how to structure your financial arrangements with your contractor. The two main choices are Cost Plus and a Fixed Bid.
With Cost Plus, you pay the contractor for the cost of materials, plus a fee of 12% to 20%. Using this method, you will need to keep excellent records in order to prove all your expenses. With Cost Plus, you are responsible for paying the Social Security tax for every person working on your home… your contractor is not.
Each time you pay the contractor, he must provide you with a legal Mexican Invoice called a Factura. Each Factura must be in your name and will include a 16% sales tax call IVA Tax. Without the Facturas, nothing you spend is deductible as an expense in Mexico.
With a fixed-bid contract, the contractor quotes you a flat fee to build your home. A fixed bid will include all labor, materials, Social Security, etc. It is all-inclusive. When using the Fixed Bid process, you put the burden of record keeping on the contractor and you do not have to pay the 16% Mexican IVA Tax each time you make a payment. You will still need to receive a Mexican Invoice, Factura, from the contractor for each payment; however, the Factura should reflect the amount of the payment due with no 16% sales tax (IVA Tax).
IVA Tax is basically a sales tax and Mexican Tax Law states there is no IVA Tax for the construction of a personal residence, provided the contractor 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 on the contractor.
TIP: When using Fixed Bid, make certain the contractor is in agreement to provide you with a Factura for each payment with no 16% sales tax added. 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 to finish the construction. The permit is pulled from the government office called “Obras Publicas”, meaning Public Works. Normally, the contractor will pull this permit and 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 proposed to do the work.
The fee for the Building Permit is based on the estimated value of your construction. In and effort to reduce this fee, some contractors will report a lower construction amount when pulling the permit. This is a huge mistake! You will want your construction costs recorded accurately, so your cost basis will be accurate for capital gains. Never report a lower construction value to save some money on the permit fee, because it will cost you much more in the long run!
Letter of termination of work
When construction is finished, and you are ready to Manifest Your Construction, you will need to take your Building Permit to the Obras Publicas office with a letter stating the amount you spent and that you have finished your construction. You or your contractor can write the letter. With this letter, you will request an official statement of completion called an “Adviso de Terminacion de Obra”, which means a “Letter of Termination 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. This letter is the document that actually establishes your construction cost basis for the tax office.
Social Security is very serious issue in Mexico and your home can actually be liened or sold to force payment if these taxes are not paid. This can even happen years after you finish your construction.
When you receive your “Letter of Termination of Works”, Obras Publicas will send a copy to the Social Security office. They will compare this amount with what you or your contractor has paid to Social Security during construction. (If you are using Cost Plus, you are responsible for paying the taxes and if you are using Fixed Bid, the contractor is responsible.)
If the amount of Social Security Taxes paid corresponds to the amount of your construction, you will receive a letter from Social Security called a “Carta de Razonabilidad de Pago”, meaning a “Letter of Reasonability of Payment”. This letter is very important, as it is your protection to prevent any future claims for non-payment of Social Security taxes.
Manifesting your construction
Once you have your “Letter of Termination of Works” and your letter from Social Security, you simply take them to the Tax Office, called the Catastro Office. They will record the value and add it 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.
If you do not have a Trust, you should not begin construction. Without the Trust document, you cannot pull a building permit in your name and you run the risk of not being allowed to deduct your land cost or construction cost when you sell.
Remember: Annual property taxes are relatively low in Mexico…capital gains taxes are not. Registering an artificially low number will cost you much, much more in the long run!
Please if you are either purchasing a home or building a new one, do not forget to check your documentation on your purchase, or to complete all of this documentation to Manifest your Construction.