Press Room: Tax Release
IRS Rules Mexican Fideicomiso is Not a Trust: No Form 3520-A/Form 3520 Reporting
IRS rules that Mexican Fideicomiso (Mexican Land Trust Arrangement or MLT) is not a trust for U.S. income tax purposes. No Form 3520A or Form 3520 filing requirement.
The Mexican Federal Constitution (Mexican Constitution) prohibits non-Mexican persons from directly holding title to real property in certain areas of Mexico (i.e., within approximately 31 miles of the coast or approximately 62 miles of any border (restricted zones)). Accordingly, Non-Mexican persons (buyer) arrange purchases of residential real property located in the restricted zones through an MLT, typically through a Mexican bank (bank), after obtaining a permit from the Mexican Ministry of Foreign Affairs. The buyer negotiates the purchase of the property directly with the seller and directly pays the seller, with no interaction from the bank. At settlement, legal title to the property is transferred from the seller to the MLT with the bank, subject to the MLT arrangement. Under the MLT arrangement, the buyer has the right to sell the property without permission from the bank, and the buyer is directly responsible for the payment of all liabilities related to the property, including payment of any taxes due in respect to the property, directly to the Mexican tax authorities. If requested by the buyer, the bank must grant a security interest in the property to a lender. The buyer has the exclusive right to possess, make any desired improvements (after receiving proper licenses and permits), and to lease the property with the buyer receiving and reporting the rental income on the buyer’s U.S. income tax return. Although the bank is identified as a fiduciary under the MLT arrangement, it disclaims all responsibility for the property (including the duty to defend or maintain the property), including obtaining clear title. The bank collects a nominal fee for acting as a fiduciary under the MLT.
IRS ruled in Rev. Rul. 2013-14 that in three situations: (1) through a disregarded US limited liability company wholly owned by a U.S. citizen, (2) a U.S. corporation and (3) directly by a U.S. citizen, the MLT arrangement is not a trust for U.S. income tax purposes, since the bank’s only duties are to hold legal title and transfer legal title at the direction of the buyer. Heretofore, some buyers were concerned that IRS could take the position that the MLT was a trust for U.S. income tax purposes (as the word fideicomiso literally means trust in Spanish) thus requiring the filing of Form 3520A and Form 3520, with potential significant penalties for non-compliance. Accordingly, buyers holding property in restricted areas through an MLT arrangement structured similarly to that in Rev. Rul. 2013-14 will no longer need to be concerned with filing Form 3520A and Form 3520.
In a somewhat related matter, there is a legislative movement in Mexico to eliminate the prohibition of non-Mexican persons from directly owning residential real estate in a restricted zone under the Mexican Constitution. The legislation is currently before the Mexican Senate (after being passed by the Chamber of Deputies), and it must also be approved by a majority of Mexico’s 32 state legislatures before the Mexican Constitution may be amended. Should such legislation ultimately pass, there would be no need for an MLT for residential real estate, but non-Mexican persons owning commercial real estate may still need to utilize an MLT arrangement. The distinction between residential and commercial real estate is not clear at this time (i.e., would vacation or other short term rentals of residential real estate render it commercial?). If the legislation does pass, care will need to be taken in unwinding the holding of residential property held in an MLT arrangement to manage potential adverse Mexican or U.S. income tax consequences, depending on the structure of the holding.