Tuesday, September 25, 2012

ISR Calculation - How Notaries Determine Capital Gains Tax in Mexico

READER WARNING: This is a deep-in-the-weeds discussion of ISR Calculations. It's long, it's boring, it's important, and it's something I get asked about all of the time. For those of you who are interested, read on. Please post any questions that you have in the "comments" section of the blog so that all can benefit from any Q&A. For those of you who don't own in Mexico, you may rather watch paint dry. Consider yourself warned...

This article assumes two things:

  • You know what the ISR tax is. If you don't, please see a previously-written article Understanding Capital Gains (ISR) Tax in Mexico.
  • You own property via a deed (if you are Mexican) or a fideicomiso (if you are a foreigner). If you own property in a Corporation, you are subject to corporate tax rates and structure.

I am going to provide two examples:

  1. You have purchased an existing home.
  2. You have purchased raw land and build a home.

At the end of the day, if you are considering selling your property, you need to consult with your attorney or notary for an estimate on Capital Gains PRIOR to listing your property for sale. It's a crucial piece of the puzzle when making decisions about selling a property.

In both examples, I will be referring to a National Index of Inflation ("Index"), which is published by Mexico's Secretary of Finance. It is called the "├Źndice Nacional de Precios al Consumidor" and is currently published here.

EXAMPLE 1: You bought a home in February of 1999 for 1,500,000.00 pesos. In September of 2012, you sell this home for 5,000,000.00 pesos.

  1. The first thing you will need to do is determine the Index numbers for both your date of purchase and your date of sale. For this example: February 1999 = 54.59408. Since you are selling in the month of September, the inflation index has yet to be published, so the month prior (August) is used = 105.279
  2. According to section I of ART 151 of ISR law, unless otherwise known, 20% of the purchase price is to be designated toward the value of the land and 80% toward the value of the construction.

    Many notaries use these figures as a default. If you feel that your case warrants an exception, discuss this with your notary.

    In our example:
    20% of 1,500,000.00 USD would be 300,000.00 pesos to be designated for the value of the land.
    80% of 1,500,000.00 USD would be 1,200,000.00 pesos designated for the value of the construction.
  3. Since new construction is worth more than older construction, a depreciation is applied to the construction on the property. According to section II of ART 151 of ISR law, construction is to be depreciated each year by 3%, with a maximum of 80% depreciation. Complete calendar years are used, not partial years.

    In our example:
    2012 - 1999 = 13 years of ownership
    13 years x 3% = 39% Depreciation
    1,200,000.00 - 39% = 732,000.00 pesos
    732,000.00 is the depreciated value of the construction at the time of sale.
  4. Next, you need to determine the coefficient of inflation. To do this, divide the Index on the date of sale by the Index on the date of purchase.

    In our example:
    105.279 / 54.59408 = 1.92
    1.92 will be used to adjust the original purchase values upwards to account for the inflation that has occurred between the time of purchase and time of sale.
  5. Determine the purchase price of the land and the depreciated construction, accounting for inflation.

    In our example:
    Land: 300,000.00 x 1.92 = 576,000.00 pesos
    Construction: 732,000.00 x 1.92 = 1,405,440.00 pesos
    So, if you were to purchase the land today (and it hadn't increased in value other than inflation), you would have paid 576,000.00 pesos for the land. And the construction is worth 1,405,440.00 pesos after depreciation and with inflation.
  6. Add the two values to obtain the original purchase price, adjusted for inflation and depreciation.

    In our example:
    576,000.00 + 1,405,440.00 = 1,981,440.00 pesos
  7. Calculate the amount of capital gain in the sale transaction by subtracting the sale price from the original adjusted purchase price.

    In our example:
    5,000,000.00 - 1,981,440.00 = 3,018,560.00 pesos
    3,018,560.00 is the amount of gain that will be realized by the seller at the time of sale.
  8. Determine the rate of ISR. The amount of gain is taxed according to two calculations. Whichever benefits the seller (the lower of the two calculations) will be used:

    The first option is a flat 25% of the sale price. [In all of the transactions that I have performed, this has never been the most beneficial for the seller. If you happen to have experienced a circumstance where this was the best option, please let me know. I'd love to know when this would apply.]

    In our example:
    5,000,000.00 x 25% = 1,250,000.00 pesos in ISR

    The second option is to tax the adjusted gain at 30%, less applicable deductions.

    In our example:
    3,018,560.00 pesos - 30% = 905,568.00 pesos (less any applicable deductions)

    In this case, the second option is most beneficial to the seller and is the example that we will continue with.

    Now let's discuss deductions ---
  9. According to section II of ART 148 of ISR law, you can deduct capital improvements in the property.  "Capital Improvements" are things that increase the value of the property, not maintain it. For instance, fixing a leaking faucet is maintenance. Constructing an addition or adding granite in a kitchen is adding real value to the property.

    In order to demonstrate the amount of improvements made in the property, facturas must be presented for the work. If you have facturas, 100% of the value can be deducted.

    Oftentimes facturas are not available. If facturas are not available, then a certified appraiser, called a perrito, can appraise the value of the upgrades. If you have before/after photos, receipts, etc. these will be handy for the perrito to review. If not, he will use standard book values for his assessment. If you use an appraisal, 80% of the appraised value of the improvements can be deducted.

    [The inflation index does not apply to improvements.]

    In our example:
    We added a new pool. We did not have a factura for the construction, so we paid for an appraisal that appraised our improvement at 200,000.00 pesos.

    200,000.00 x 80% = 160,000.00 pesos
  10. There are various taxes, fees, notary fees that you paid when you purchased the property. According to section III of ART 148 of ISR law, these can be deducted and the inflation index applied.

    In our example:
    For the sake of this discussion, let's say that I have receipts and facturas that total 10,000.00 pesos from the time of purchase for the various taxes and fees that are applicable.

    10,000.00 pesos x 1.92 = 19,200.00 pesos [Amount of Deduction for Purchase Expenses]
  11. Section IV of ART 148 states that you are able to deduct real estate commissions that were paid at the time of purchase or sale of the property, providing you have the facturas from your agent. Inflation index is applicable, when necessary.

    In our example:
    I purchased the property through a standard transaction and did not pay any commissions at the time of purchase. If I would have paid some sort of fee, I would multiply the amount of the fee by 1.92 for the adjusted amount.

    When I sell my property, I will pay 300,000.00 pesos for the real estate commission. Since this is a current price, no adjustment for inflation is necessary.

    So, my total deduction for real estate commissions is = 300,000.00 pesos

    [This is a SUBSTANTIAL deduction! While it's a shameless plug, may I suggest that you use a professional agent that is able to supply you with a factura? It will benefit you in the long run!]

  12. Calculate the total ISR: Take the sale price and subtract the adjusted purchase price (#6), the capital improvements deduction (#9), the purchase expenses deduction (#10), and the real estate commissions deduction (#11). Take the result of that subtraction and multiply by the 30% ISR tax rate.

    In our example:
     5,000,000.00 (Sale price)
     1,981,440.00 (Adjusted/Depreciated Purchase Price)
        160,000.00  (Capital Improvements)
          19,200.00  (Purchase Expenses)
    -   300,000.00  (Real Estate Commissions)

    2,539,360.00 x 30% = 761,808.00 pesos in ISR that is payable at the time of sale.

EXAMPLE 2: You bought a raw land in February of 1999 for 300,000.00 pesos. You built construction on that property for a sum of 2,000,000.00 pesos in Jan 2005. You sell the property for 5,000,000.00 pesos in September of 2012.

  1. Determine the coefficient of inflation. To do this, divide the Index on the date of sale by the Index on the date of purchase.

    In our example:
    [See #1 in Example 1 for where these Index numbers were determined.]
    105.279 / 54.59408 = 1.92
    1.92 will be used to adjust the original purchase values upwards to account for the inflation that has occurred between the time of purchase and time of sale.

  2. Determine the value of the purchase, adjusted upward for inflation.

    In our example:
    300,000.00 pesos x 1.92 = 576,000.00 pesos
    576,000.00 pesos represents the value of your land, with inflation.
  3. Determine the original value of the construction and depreciate it for the time that it has existed.

    In our example:
    Per an appraisal, as described above in Example 1: #9, the value of my construction is established at 2,000,000.00 pesos. Since an appraisal was required, I can only deduct 80% of my construction.

    2,000,000.00 x 80% = 1,600,000.00 pesos
    This is the base value for our construction deduction. However, we now must depreciate it, as it is not brand new construction.

    2012-2005 = Construction is 7 years old.
    7 years x 3% depreciation = 21%  [See Example 1: #3]

    1,600,000.00 - 21% = 1,264,000.00 pesos
    This is the value of my construction with depreciation.
  4. Determine your Index Coefficient for the time from the year that you built the house until the year that you are selling. [See Example 1: #4]

    In our example:
    We built in Jan 2005.
    We are selling in September 2012. Since the Index for September isn't available, we use the Index for the month prior, August.

    Jan 2005 Index: 77.61649
    Aug 2012 Index: 105.279

    105.279 / 77.61649 = 1.35
  5. Adjust your value of construction for inflation

    In our example:
    1,264,000.00 x 1.35 = 1,706,400.00
    This is the value of the construction, considering depreciation and inflation.
  6. Determine the adjusted value of the property, considering the adjusted land value and adjusted construction value.

    In our example:
    1,706,400.00 (Value of construction)
    + 576,000.00 (Value of land)
  7. Calculate the amount of capital gain in the sale transaction by subtracting the sale price from the original adjusted purchase price.

    In our example:
    - 2,282,400.00
  8. Apply the 30% ISR Tax rate to the transaction.

    In our example:
    2,717,600.00 x 30% = 815,280.00 pesos
    If you had no further deductions (See #9 below), you would pay 815,280.00 pesos in ISR tax at the time of sale.
  9. Just as in Example 1, you could apply additional deductions for purchase expenses and real estate commissions to further reduce the amount of ISR owed.


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Amber Pierce-Schulz is the Broker/Owner of Mayan Riviera Properties, specializing in Puerto Morelos Real Estate and Puerto Morelos Vacation Rentals. We are members of AMPI and Federally Certified Realtors.