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A recent incident that occurred to a local U.S. ex-pat living in Mexico emphasizes the IRS’ efforts to collect taxes and enforce taxation reporting legislation, even on the fun side of the wall.

While on a return trip to the U.S., Tom Smith (the individual’s identity is being withheld) and his family were intercepted at customs and repeatedly asked whether he was the “Tom Smith” that was identified by the passport. After confirming his identity, his family was authorized to enter the U.S., and he was detained. Hours later, a representative of the IRS introduced herself and proceeded to advise him that his passport was being seized, his American bank accounts were garnished and, unless he wanted to be detained in a federal penitentiary, he would have to provide a $50,000 bail bond after appearing before a Federal Circuit Judge the same day. What was his crime? Money-laundering? Drug trafficking? No; failing to report property and income on his U.S. tax returns. The situation has now been resolved, however, he was treated like a criminal, and paid more than 50% of the undeclared income as well as fines and penalties, not to mention legal and accounting services, which were double the amount that was not reported.

U.S. investors and owners of foreign property have special tax and reporting obligations to comply with.  In general, investors and owners of property who are U.S. citizens or permanent residents must report and pay income taxes on their worldwide income which includes any income earned from foreign property.  This is true for rental income as well as capital gains realized from the sale of foreign property.  Furthermore, U.S. citizens have specific reporting requirements that very few of them are aware of until they are assessed or penalized by the IRS.  This is particularly true for U.S. citizens that purchase real estate in certain restricted areas of Mexico through a Mexican corporation or a bank trust, otherwise known as a “fideicomiso”.  

This article examines reporting requirements for U.S. Citizens who own property in Mexico.  In a subsequent article, we will deal with the income tax implications and obligations relating to this property.

The first requirement applicable to all U.S. citizens is the obligation to report any foreign bank account or investment account valued at more than $10,000 USD (or equivalent in another currency) at any time during the calendar year.  This form is known as a Foreign Bank and Financial Accounts Report (FBAR) and has nothing to do with income or income taxes. Therefore, it must be filed separately from income taxes and sent directly to the Department of the Treasury. The form can be obtained and filed online at www.bsaefiling.fincen.treas.gov and must be filed before April 15.

The obligation is imposed on any U.S. citizen that has a financial interest in or signing authority over bank accounts in a foreign country. This is specifically the situation that most U.S. citizens find themselves in when purchasing real estate in Mexico through a bank trust or a Mexican corporation. Along with the usual process for acquiring property in the restricted zone, U.S. citizens often open bank accounts for their bank trust or Mexican corporation to administer operations in Mexico. Although the account is not in their personal name, they do have an interest in that account as well as signing authority. The only exception to this rule is for owners and beneficiaries of U.S. IRAs.

Failing to file this form will result in severe penalties being imposed, which include a fine of $128,000 or 50% of the balance of the account at the time of the violation, whichever is greater.  If you have not already filed this form, it’s not too late, as the IRS will permit you to file it late by providing an explanation. Fortunately, the IRS has already anticipated “I did not know that I had to file” as a reason for not filing on time. You must file this form regardless if you have reported this asset on any other form or tax return.

Another obligation few U.S. taxpayers are familiar with is the obligation to file a Statement of Specified Foreign Financial Assets, known as Form 8938.  This applies to any U.S. taxpayer who has a beneficial interest in a foreign asset valued at $50,000 USD or more for an individual taxpayer or $150,000 USD or more for married taxpayers filing together.  Financial assets include any interest in a foreign entity such as a bank trust or Mexican corporation used to purchase real estate in the restricted zone.  If you own property in Mexico directly, then you do not need to file this form. This form must be filed with your income tax declarations for the year in which the property was acquired. Again, serious penalties apply for failing to file this form punctually.

If you purchased your property in Mexico using a bank trust, you would also be obliged to file form 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner) by each beneficiary (example: spouses). If you purchased your property using a Mexican corporation, you must file Form 5471, if you control ten percent or more of the foreign corporation.

In summary:

  • All U.S. citizens must file an FBAR form if they have a foreign bank account with $10,000 USD or more before April 15;
  • If you own foreign real estate through a trust or corporation with a value greater than $50,000 (single individual) or $150,000 (spouses) you must file an 8938 form with your tax returns for the year in which the property was purchased;
  • If you own foreign real estate through a trust, you must file a 3520-A form with your tax returns for the year in which the property was purchased;
  • If you own foreign real estate through a corporation and you control 10% or more of the shares, you must file a 5471 form with your tax returns for the year in which the property was purchased.

Now that you have complied with your reporting requirements, it’s time to report income earned from those foreign assets.

* This is the first of a two-part article on fiscal obligations of U.S. citizens in Mexico.