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Oscar A. López Velarde, Juan José Paullada Eguirao, and Fernando Caballero Gout of Ritch Mueller present structuring possibilities for real estate investment funds in Mexico.
In Mexico, the real estate business is one of the few with appropriate tax benefits. However, it is likely the industry with the largest number of investors who are subject to distinct tax systems.
Given that there is no "one-size-fits-all" solution, it is essential to comprehend the many tax consequences and structuring options for real estate investments in order to maximise results.
Real estate taxation systems
As context for introducing the most frequent real estate investment structures in Mexico, the following is a quick summary of the various applicable tax regimes for real estate investors.
Mexican Residents
Net capital gains arising from the sale of real property located in Mexico are subject to income tax at a rate of 35% for people who are Mexican residents.
The same taxes applies to rental income. Individuals may either claim the statutory available deductions (no net operating loss (NOL) carryforwards are permitted) or use a 35 percent default deduction to their rental income in order to compute their rental taxable income.
The second option is often less desirable for new developments since it taxes gross rental revenue at a rate of 22.5 percent, as opposed to taxing net rental income after construction depreciation and interest expenditures.
Mexican businesses
Net capital gains and rental income are subject to a corporate income tax of 30 percent for Mexican firms. For the purpose of computing net rental income, companies may deduct the majority of their capital and operating expenditures and may carry forward their NOLs for ten years.
Foreign residents
Foreign citizens who derive income from the sale of real estate located in Mexico may choose to be taxed at either the 25% rate on gross proceeds or the 35% rate on net income. However, a 25% withholding tax is imposed on the gross profits of rental income earned by non-Mexican residents from immovable property located in Mexico (zero deductions).
Except for the Mexico-United States double tax treaty (DTT), all Mexican double tax treaties (DTTs) lack the benefits applicable to capital gains taxes and rental income. This introduces an optional regime for rental income, under which the tax may be assessed at 30 percent of the net basis (taking into account deductions such as interest), as if such income were due to a permanent presence in Mexico.
Funds for Mexican Pensions
Pension funds in Mexico, such as SIEFORES, are free from real estate income tax if the money is collected directly or via transparent vehicles (such as Mexican trusts). If Mexican pension funds invest through Mexican firms, the exemption is gone (blockers).
Foreign Pension Funds
Foreign pension funds are free from income tax on capital gains and rental income to the degree that they are regarded the beneficial owners of such income and are exempt from income tax in their home country.
Foreign pension funds are protected from capital gains if they have leased the related property for at least four years. In contrast to Mexican pension funds, international pension funds are exempt when investing via Mexican firms, subject to specific restrictions.
Choosing a structure for an investment property fund
Developing real estate developments need either capital inputs or debt as funding sources. Although the latter option is relatively prevalent in a number of jurisdictions, taxpayers must take into account the significant issues this presents under Mexican tax law.
This is especially owing to anti-avoidance measures designed to combat base erosion through the payment of tax-deductible interest. These include thin capitalisation, back-to-back loans, and other methods of limiting taxable income before interest, taxes, depreciation, and amortisation (EBITDA).
Equally crucial is the definition of the organisational structure required to harness and channel these resources. Investors must evaluate, identify, and select from a vast selection of legal organisations or vehicles that not only enable flexible corporate governance, but also accomplish tax transparency.
Specifically, following the 2020 reform, foreign transparent investment vehicles that are successfully managed in Mexico, such as Limited Partnerships, may be deemed Mexican resident firms for tax purposes, therefore losing their tax transparency.
This provides a corporate layer that prevents some types of investors from accessing favourable tax regimes (such as foreign pension fund exemptions). In recent years, this difficulty has resulted in complicated and expensive company restructurings.
Mexican institutions of trust (fideicomisos)
Fideicomisos are the most frequent investment vehicle for real estate. Despite the fact that these vehicles are composed of agreements controlled by Mexican law, parties may agree to a foreign jurisdiction as the agreement's controlling law through a Master Beneficiaries Agreement (MBA).
Depending on the sources of their income, fideicomisos may qualify as business or passive income trusts for Mexican tax purposes. (Rental revenue is a form of passive income.)
Passive income trusts are straightforward flow-through structures, whereas business trusts must file annual tax filings regardless of payouts (impacting cash-flow benefits). Additionally, business trusts can establish a permanent establishment (PE) for non-Mexican residents.
Foreign residents typically form a Mexican blocking business to avoid the gross taxes of rental revenue, however they may invest directly if rental income is negligible.
Mexican real estate investment trusts (REITs)
A REIT, also known as FIBRA, is an alternative structure. FIBRAs are publicly listed entities that must buy or build real estate assets for at least four years of lease operations.
Despite the complexities of owning a publicly listed vehicle, FIBRAs are tax-wise extremely appealing vehicles. FIBRAs allow a step-up in basis for property provided to the trust, deferral of the income tax caused by the donation of the property, and taxation at the 30 percent rate without dividend withholding for people and foreign residents.
In addition, tax exemptions for both Mexican and international pension plans are maintained, and capital gains for the transfer of FIBRAs certificates are exempt for both Mexican and foreign persons. These are some of the advantages of FIBRAs that may lead to increased profits.
In conclusion, the tax consequences of structuring investments in Mexican real estate assets can vary substantially based on the type of investor and the vehicles or corporations created to channel the investment.
Therefore, it is essential to conduct a thorough examination of the consequences and dangers outlined in this article to minimise any excessive tax leakages that might eventually affect an investment's return.
By fLEXI tEAM