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George F. Bearup, J.D. Senior Legal Trust Advisor

8-May-19

Neighboring Trusts: Canada and Mexico

Take-Away: US citizens often acquire residential real estate in Canada and Mexico, either as winter vacation homes or summer hunting and fishing cabins. It is a mistake to assume that the normal rules with regard to real estate held in a trust that we follow in the U.S. will apply when real estate is acquired in one of our next-door neighbors.

Background: The United States and Canada are both common law jurisdictions that each have long legal histories that recognize the validity of trusts as an asset holding/distribution mechanism. Mexico is a civil law jurisdiction; most civil law countries do not formally recognize trusts, although that is a trend that seems to be changing, at least in Europe. A short summary of how each neighboring country treats real estate held in trust follows.

Canada: Even in a common law jurisdiction, like Canada, trusts are often treated differently than they are in the United States. For example, in England, a common law jurisdiction, a tax is imposed on the settlor’s transfer of title to a trust, even a revocable grantor trust.

  • Not a Separate Legal Entity: A trust is not a separate legal entity in Canada (e.g. a Canadian trust cannot enter into contracts or incur liability.) However, a trust is treated as a taxpayer that pays income taxes at the highest marginal rate (similar to how trusts are taxed in the U.S.) Each province imposes its own tax rate. Taxation is highly complicated when there are Canadians and non-Canadian beneficiaries of the same trust. In addition, several elections apply with regard to the taxation of income that is generated by the Canadian trust’s assets, e.g. a formal election is required to avoid a 25% mandatory withholding tax imposed on gross rental income.
  • Closing Tax: There is a 15% ‘closing tax’ when real property is acquired in a Canadian trust [called the Non-Resident Speculation Tax.]
  • 21 Year Deemed Disposition: A trust that holds Canadian real property will be subject to periodic taxation every 21 years- the equivalent to an imputed sale or deemed disposition every 21 years that, in turn, causes a capital gains tax to be paid on the appreciated assets then held in the trust. [Sections 94(5) and 104(4) of the Canada Income Tax Act.]

Mexico: Mexico is a civil law jurisdiction, yet it will indirectly recognize a trust-like relationship. The Mexican equivalent of a trust relationship is called a fideicomiso. [No, I do not know how to pronounce it, let alone spell it!]

  • Restricted Zone: A fideicomiso is required to be used by non-Mexican nationals to acquire and hold real estate in what is called the restricted zone. The restricted zone includes 50 kilometers from all Mexican coastlines [think condominiums located in Cancun, Cozumel and Acapulco] and 100 kilometers from all Mexican borders. If the real estate located in the restricted zone will be used for residential purposes, it may only be owned by Mexican nationals and/or Mexican legal entities (which entities may not be owned by non-Mexican persons.) If the real estate will be used for nonresidential purposes in the restricted zone, the real estate may be owned by a Mexican entity, which entity can be owned by a non-Mexican individual.
  • Fideicomiso (Trust): Residential estate must be titled in the name of a Only a Mexican bank or financial institution can serve as trustee of the fideicomiso. While title to the real estate is held in the name of the trustee, the non-Mexican beneficiary may possess all of the rights to use, lease, or sell the rights identified in the fideicomiso. A special permit must be issued by the Mexican government for a fideicomiso. The permit is valid for 50 years, which can be renewed.
  • Beneficiaries: A fideicomiso can have US beneficiaries or legal entities like an LLC, or a US based trust, as the named beneficiary. Initially there was some debate if a U.S. revocable trust could be named as the beneficiary of a That uncertainty was clarified and a revocable trust can now be named as a current or successor beneficiary of a fideicomiso. Tip: An LLC can also be named as beneficiary or successor beneficiary of the fideicomiso; an LLC may be more acceptable to the fideicomiso trustee than an irrevocable trust of the deceased settlor-beneficiary because a successor trustee normally will have to prove its authority to act on the irrevocable trust’s behalf.
  • Transfer Taxes: Most fideicomiso instruments do not address federal estate taxes. Tip: The value of the Mexican real estate could be subject to federal estate taxation since US citizens are taxed on their worldwide property interests. The form fideicomiso instrument should therefore be modified to address specifically the family that plans to benefit from the fideicomiso, including the use of the unlimited federal estate tax marital deduction to defer the federal estate tax on the death of a settlor-spouse-beneficiary. The fideicomiso instrument should also clearly identify the successor beneficiaries and not rely on the fideicomiso’s boilerplate provisions.
  • Wills and Probate: Often the fideicomiso trustee will not accept a pour-over Will. Rather, the trustee will require a formal probate proceeding in the U.S., followed by a probate court order, which order then must be domesticated in Mexican courts, all of which must take place before a beneficial interest in the fideicomiso actually passes to the named successor beneficiary. Tip: Due to this multi-step procedure, it might be wise to have two Wills; one Will for the trust beneficiary’s U.S. based property and another Will that deals solely with the decedent’s beneficial interest in the fideicomiso that holds the Mexican real estate.
  • Foreign Trust Reporting: Elaborate annual reporting responsibilities are imposed when a U.S. individual establishes a foreign trust. [Examples of these yearly filings include-IRS Forms 3520, 3520-A, 8938, and possibly Form TD F 90-22.1] One question is whether a fideicomiso constitutes a foreign trust, which triggers the massive annual reporting responsibilities that are imposed upon a foreign trust, if all it holds is a title to a Mexican condominium. The IRS provided limited guidance on this question in a 2013 Revenue Ruling. In that Revenue Ruling the IRS held that, a fideicomiso will not be viewed by the IRS as a foreign trust. [Revenue Ruling 2013-14.] However, that Revenue Ruling was limited to the terms of the fideicomiso, which specified that the fideicomiso trustee only held title to the Mexican real estate and that the trustee did not engage in any other activity other than passively hold title to real estate. Tip: Since the reporting obligations imposed on a foreign trust are onerous, it would be wise to try to conform the fideicomiso instrument as close as possible to the trust that was described in great detail in the 2013 Revenue Ruling.

Conclusion: Individuals return from spring vacations in Mexico planning to purchase their dream condominium in Cancun using their estate planning revocable trust. Other individuals intend to acquire their fishing cabin retreat in the Canadian wilderness, using their trust to take title to the real estate. A working knowledge of the technical ‘trust’ laws of Mexico and Canada that are intended hold real estate is critical when that foreign sitused real estate is integrated into their estate plans.