IRS Rules that Mexican Land Trusts Are Not Foreign Trusts; Foreign Reporting Obligations Don't Apply. (Parker's Federal Tax Bulletin: June 19, 2013)

A recent IRS ruling on Mexican Land Trusts (MLTs), which are popular with individuals buying Mexican vacation or retirement homes, is good news for taxpayers. Prior to the ruling, there had been a lot of uncertainty about whether U.S. taxpayers who set up such trusts were required to comply with onerous tax reporting requirements involving foreign trusts. In Rev. Rul. 2013-14, the IRS ruled that MLTs are not trusts for U.S. federal tax purposes and, thus, the burdensome foreign reporting requirements do not apply.

Background

The Mexican Federal Constitution prohibits non-Mexican citizens from owning real property located within 100 kilometers of Mexico's inland borders or within 50 kilometers of its coastline. These areas are known as the restricted zones, and only Mexican citizens (or Mexican corporations whose bylaws forbid the ownership of stock by non-Mexican citizens) are allowed to directly own real property within the restricted zone.

Non-Mexican persons, however, may hold residential real property located in the restricted zones through an MLT with a Mexican bank after obtaining a permit from the Mexican Ministry of Foreign Affairs. As a result, U.S. taxpayers who want to purchase vacation or retirement homes often use MLTs to purchase Mexican real estate.

Foreign Trust Reporting Requirements

Under Code Sec. 6048(a), U.S. persons (and executors of estates of U.S. decedents) must file Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, to report (1) certain transactions with foreign trusts, and (2) ownership of foreign trusts under the grantor trust rules. A separate Form 3520 must be filed for transactions with each foreign trust. Under Code Sec. 6048(b), a foreign trust is any trust other than a domestic trust. A domestic trust is any trust if (1) a U.S. court is able to exercise primary supervision over the administration of the trust; and (2) one or more U.S. persons have the authority to control all substantial decisions of the trust.

In addition, any foreign trust with a U.S. owner is required to file a Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner, and give copies of the Foreign Grantor Trust Owner Statement (page 3 of Form 3520-A) and Foreign Grantor Trust Beneficiary Statement (page 4 of Form 3520-A) to the U.S. owners and U.S. beneficiaries.

In addition, under recently enacted Code Sec. 6038D, any individual who, during any tax year, holds any interest in a specified foreign financial asset must attach to his or her income tax return for the tax year certain information with respect to each such asset if the aggregate value of all such assets exceeds a threshold amount.

Rev. Rul. 2013-14

Earlier this month, the IRS issued Rev. Rul. 2013-14, in which it examined the following three situations involving MLTs.

Situation 1

In Situation 1, a U.S. individual is the sole owner of a limited liability company (LLC) organized under the laws of a state in the United States. The LLC is disregarded as an entity separate from its owner. The individual, through LLC, wants to buy Mexican residential real property located in a restricted zone. Neither the individual nor the LLC may hold title to the property directly under Mexican law. The LLC obtained a permit from the Mexican Ministry of Foreign Affairs and signed an MLT agreement with a Mexican bank. The LLC negotiated the purchase of the property directly with the seller of the property and paid the seller directly. The seller had no interactions with the Mexican bank with respect to the sale. At settlement, legal title to the property was transferred from the seller to the bank, subject to the MLT agreement, as of the date of sale.

Under the terms of the MLT agreement, the LLC has the right to sell the property without permission from the bank. Further, the bank must grant a security interest in the property to a third party, such as a mortgage lender, if the LLC so requests. The LLC is directly responsible for the payment of all liabilities relating to the property and must pay any taxes due in Mexico with respect to the property directly to the Mexican taxing authority. The LLC has the exclusive right to possess the property and to make any desired modifications, limited only by the need to obtain the proper licenses and permits in Mexico. If the property is occasionally leased, the LLC directly receives the rental income and the individual, as the owner of the LLC, reports the income on his U.S. federal income tax return. Although the Mexican bank is identified as a fiduciary in the MLT agreement, it disclaims all responsibility for the property, including obtaining clear title. The bank has no duty to defend or maintain the property. The bank collects a nominal annual fee from the LLC. There is no other agreement or arrangement between or among the individual, the LLC, the bank, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.

Situation 2

In the second situation, the facts are the same as in Situation 1 except that the LLC is a corporation organized under U.S. state law. The LLC is treated as a corporation under Reg. Sec. 301.7701-2(a). If the property is occasionally leased, the corporation directly receives the rental income and reports the income on its U.S. federal income tax return.

Situation 3

The facts are the same as in Situation 1 except that the individual deals directly with the Mexican bank without interposing any other entity. The individual obtained the permit from the Mexican Ministry of Foreign Affairs, signed the MLT agreement with the Mexican bank, and negotiated the purchase of the property. Additionally, the provisions of the MLT agreement that apply to the LLC in Situation 1 instead apply to the individual. If the property is occasionally leased, the individual directly receives the rental income and reports the income on his U.S. federal income tax return. The bank collects a nominal annual fee from the individual and there is no other agreement or arrangement between or among the individual, the bank, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.

IRS Analysis

The IRS began its analysis of whether the MLTs is the three situations above were trusts for U.S. tax purposes by looking at the regulations. Reg. Sec. 301.7701-4(a) provides that the term trust refers to an arrangement created by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of a trust may be the persons who create it, and the entity will be recognized as a trust if it was created for the purpose of protecting and conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally, an arrangement is treated as a trust if it can be shown that the purpose of the arrangement is to vest in trustees the responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility.

The IRS then looked at Rev. Rul. 92-105, which addresses the transfer of a taxpayer's interest in an Illinois land trust under the like-kind exchange rules of Code Sec. 1031. Under the facts of the ruling, an individual taxpayer created an Illinois land trust and named a domestic corporation as trustee. Under the deed of trust, the taxpayer transferred legal and equitable title to the real property to the trust, subject to the provisions of an accompanying land trust agreement. The land trust agreement provided that the taxpayer retained exclusive control of the management, operation, renting, and selling of the real property, together with an exclusive right to the earnings and proceeds from the real property. Under the agreement, the taxpayer was required to file all tax returns, pay all taxes, and satisfy any other liabilities with respect to the real property. Rev. Rul. 92-105 concludes that, because the trustee's only responsibility was to hold and transfer title at the direction of the taxpayer, a trust, as defined in Reg. Sec. 301.7701-4(a), was not established. The ruling holds that, on the facts described in the ruling, the trustee was a mere agent for the holding and transfer of title to the real property, and the taxpayer retained direct ownership of the real property for federal income tax purposes.

Ruling's Conclusion

In Situation 1, the IRS concluded that because the bank's only duties under the MLT agreement are to hold the legal title to the property and transfer title at the direction of the LLC, the MLT is not a trust. Because the LLC is treated as a disregarded entity, the individual who owns the LLC is treated as the owner of property.

In Situation 2, the IRS also ruled that the MLT is not a trust under the same analysis as in Situation 1 except that, because the LLC is treated as a corporation, the corporation is treated as the owner of property.

Finally, in Situation 3, the IRS concluded that because the bank's only duties under the MLT agreement are to hold the legal title to the property and transfer title at the direction of the individual, the MLT is not a trust. The individual is treated as the owner of the property.

CAUTION: The IRS did add, however, that the conclusions in Rev. Rul. 2013-14 don't apply if, under the MLT agreement, the bank holds legal title to any assets other than the property discussed in the ruling or if the bank is permitted or required to engage in any activity beyond holding legal title to such property.

Staff Editor Parker Tax Publishing

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Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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