My friend just sold land in Mexico, will he have to also pay capital gains tax in the US?

Question

I understand there is a credit for any tax paid in another country. Is this true of capital gains as well?

In 1999 he bought land for $40,000 and he just sold it for $80,000.

He believes he will pay about 25% on the gain once all the paperwork is complete. Thats $10,000!

Once he brings his proceeds to the U.S., will he be taxed on the whole $40k of profit, or on the net $30K of profit?

will he be given credit for the capital gains tax he already paid?

also, can he increase his cost basis by the cost of traveling to the land to make sure no squaters had started building anything on his plot of land?

Answer 1

Assuming that he's a US citizen or lawful permanent resident the sale is fully taxable in the US.

He has a long-term CG of $40k.  The US tax on that will be 15% of the $40k ($6,000) unless his marginal rate inclusive of the gain is 15% or less where it will drop to the reduced rate which is normally 5% but for 2008 and 2009 will be 0%.  

(Quick guess:  If his filing status is Single, it will be taxed at 15%.  If he's Married Filing Jointly he MIGHT qualify for the reduced rate of 0% if this gain is MOST of his income for the year.  You'll have to run the numbers to see.)

File Form 1116 to claim a credit for any foreign income taxes paid on the gain.  The credit is limited to what the US tax would have been.  At best, it will wipe out the US tax and it appears that it will do so in his case.   Bear in mind that Form 1116 is for the INCOME taxes only.  If any of the taxes he's paying in Mexico are other than income taxes (transfer taxes, deed registration taxes, etc.) then those are used to adjust the net proceeds from the sale.  Do NOT include those on the Form 1116!

His tax liability in the US is triggered immediately upon completion of the sale, NOT the repatriation of the funds.  Even if the funds were kept in Mexico, the gain would be taxable in the US.

A single inspection trip prior to the sale might be reasonable and would be included as a selling expense.  Just be sure that he can document that that was the principal reason for the trip.  If it's combined with pleasure then he will have to apportion the costs of the trip and if the principal reason for the trip was pleasure then only the proportional share of any hotel and meal costs are includable as selling costs; travel would NOT be includable if the principal purpose was pleasure.