The US-Mexico Income Tax Convention — commonly referred to as the US-Mexico tax treaty — has been in force since January 1, 1994. It is a 32-article bilateral agreement that governs the tax treatment of income and gains flowing between the two countries for residents of each. For US citizens buying luxury real estate in Los Cabos, it is not optional reading — it determines how rental income is taxed, how capital gains at resale are structured, and what compliance obligations follow from property ownership across an international border.
This article covers the treaty provisions most directly relevant to individual US investors in Mexican real estate. It is educational, not legal advice. The specifics of how these provisions apply to your situation depend on your ownership structure, residency status, income profile, and estate objectives — all of which require analysis by a qualified cross-border tax attorney.
Double Taxation Framework: The Core Protection
The fundamental purpose of any bilateral tax treaty is to prevent the same income from being taxed twice — once in the country where the income is earned (Mexico, for a Cabo property) and again in the country of residence (the US, for a US citizen). Without a treaty, a US owner of a Mexican rental property would owe Mexican income tax on the rental income and full US income tax on the same amount, with no relief mechanism.
The treaty solves this through two mechanisms working together: source-country taxation rights and the foreign tax credit. Mexico, as the source country, retains the primary right to tax income from Mexican real estate — rental income, business profits attributable to a Mexican permanent establishment, and gains from Mexican real property. The US then allows the taxpayer to claim a foreign tax credit for the Mexican tax paid, reducing (and in most cases eliminating) the US tax owed on the same income.
Rental Income: Withholding Rates and the Deduction Election
Mexican law requires withholding on rental income paid to foreign landlords. The default withholding rate is 25% of gross rental receipts. However, the treaty's domestic law provisions allow foreign property owners who are residents of Mexico (FM2/FM3 or Permanent Resident status) to elect the deduction regime instead — paying approximately 30% on net income after allowable deductions (maintenance, management fees, depreciation, property tax, and trust fees).
For a well-managed luxury villa with significant deductible operating expenses, the net income regime frequently results in a lower effective tax rate than the 25% gross withholding. The calculation depends on your specific operating cost structure and rental yield. A Mexican tax accountant (contador) should run both scenarios annually to optimize the filing position.
On the US side, the rental income — net of the Mexican tax paid — must be reported on Schedule E of your Form 1040. The foreign tax credit for Mexican taxes paid is claimed on Form 1116. If your Mexican tax rate exceeds your US marginal rate on the same income (possible at lower income levels), you generate excess foreign tax credits that can be carried forward for up to 10 years.
Capital Gains at Resale: Article 13 and the Exemption Provision
When you sell a Mexican property, Article 13 of the treaty grants Mexico the primary right to tax the gain. The Mexican capital gains tax applies at:
- 25% of gross proceeds (the simpler calculation, no deduction for cost basis), or
- Approximately 35% of net gain (proceeds minus adjusted cost basis, acquisition costs, improvement costs, and inflation adjustment under the INPC factor)
Your notario (closing attorney) will run both calculations at the time of sale and apply the lower result. For properties that have appreciated substantially from a well-documented cost basis with significant improvements, the net gain method typically yields a meaningfully lower Mexican tax obligation.
The treaty's Article 13(6) provides a partial exemption for gains on a property used as a primary residence. The exemption applies to gains up to 700,000 UDIs (Unidades de Inversión — a Mexican inflation-indexed unit), which at current values approximates $180,000–$220,000 USD. To qualify, the property must have been your principal residence for at least three of the five preceding years — a bar that most foreign buyers with Cabo second homes will not clear, but which is relevant for full-time expat residents.
On the US side, the gain must be reported on Schedule D. The foreign tax credit claimed for the Mexican capital gains tax paid offsets the US federal capital gains tax on the same gain. For long-term gains (property held more than one year), the US rate is 0%, 15%, or 20% depending on taxable income — typically below the Mexican rate on the net gain calculation, meaning the foreign tax credit will generally cover most or all of the US tax liability.
FBAR and FATCA: The Compliance Obligations You Cannot Ignore
Owning a Mexican bank account as a US citizen triggers two separate federal disclosure regimes that operate independently of the tax treaty.
FBAR (FinCEN Form 114): Any US person with a financial interest in, or signature authority over, foreign bank accounts with an aggregate value exceeding $10,000 at any point during the calendar year must file an FBAR annually with FinCEN (the Financial Crimes Enforcement Network). The FBAR is filed electronically and is separate from your federal tax return. Penalties for willful non-compliance start at the greater of $100,000 or 50% of the account balance per year. Non-willful violations carry $10,000 per account per year. These are not theoretical penalties — the IRS has significantly increased FBAR enforcement.
FATCA (Form 8938): The Foreign Account Tax Compliance Act requires US taxpayers to report specified foreign financial assets exceeding threshold amounts ($50,000 for single filers on the last day of the year, or $75,000 at any point; $100,000/$150,000 for joint filers) on Form 8938, attached to the federal return. FATCA is broader than FBAR and may capture interests in foreign trusts — including the fideicomiso — depending on how it is classified for US tax purposes.
The practical compliance approach: engage a CPA or cross-border tax attorney who specializes in US-Mexico situations in the year you complete your acquisition, and maintain annual compliance with both regimes going forward. The cost of proper compliance is a fraction of the penalties for non-compliance.
Ownership Structure: LLC vs Individual Fideicomiso
Most individual buyers hold their Cabo property through a personal fideicomiso — the bank trust structure mandated for foreign ownership of coastal real estate in Mexico. This is the simplest and lowest-cost structure: annual trust fees of $600–$1,200, no separate corporate filing obligations in Mexico, and direct beneficial ownership by the individual or couple.
A US LLC as fideicomiso beneficiary adds a layer of liability protection and can facilitate ownership by multiple partners or family members with defined membership interests. For estate planning purposes, it can simplify the transfer of beneficial interest without requiring a formal change to the fideicomiso trust itself. The trade-off is additional annual compliance cost (US LLC filing, potential Mexican branch reporting) and complexity that may not be warranted for a straightforward personal-use property.
The decision between structures should be made with a cross-border attorney who understands both the Mexican fideicomiso regime and the US tax classification rules for foreign trusts. Do not make this decision based solely on the recommendation of a real estate agent or property manager — the stakes are too high for informal advice.
For the mechanics of the fideicomiso itself, our dedicated guide for American buyers covers the complete legal structure. For current market data to inform your investment timing, review our Q3 2025 market report. When you are ready to move forward, our team can connect you with the legal and tax professionals we trust for these transactions.
Frequently Asked Questions
Does the US-Mexico tax treaty eliminate double taxation on rental income from a Cabo property?
The treaty does not eliminate Mexican withholding on rental income, but prevents double taxation through the US foreign tax credit mechanism. Mexico withholds at 25% of gross rental receipts (or ~30% of net income under the deduction regime). US residents claim a foreign tax credit for Mexican taxes paid, offsetting their US tax liability on the same income. Effective rate equals the higher of the two country rates, not the sum.
What is the capital gains tax treatment when selling a Cabo property as a US citizen?
Under Article 13, gains are taxable in Mexico at 25% of gross proceeds or approximately 35% of net gain — whichever is lower at time of sale. US citizens also report the gain to the IRS but receive a foreign tax credit for Mexican tax paid. The Article 13(6) primary residence exemption (up to ~$180,000–$220,000 USD gain) requires the property to have been your principal residence for three of the prior five years.
Do US citizens need to report a Mexican bank account under FBAR and FATCA?
Yes. US citizens with Mexican bank accounts exceeding $10,000 aggregate at any point during the year must file FinCEN Form 114 (FBAR) annually. FATCA reporting on Form 8938 applies at higher thresholds. Mexican banks are FATCA-compliant and report US account holder data directly to the IRS. Non-compliance penalties start at $10,000 per account per year for non-willful violations — significantly more for willful non-filing.
Is it better to hold a Cabo property through an LLC or a fideicomiso?
An individual fideicomiso is simpler and lower-cost for personal-use properties: $600–$1,200 annual trust fees, no separate corporate filing, direct beneficial ownership. A US LLC as fideicomiso beneficiary adds liability protection and estate planning flexibility for investors with complex family or partnership structures. The choice should be made with a cross-border attorney, not a real estate agent.