IRS Rules that Mexican Land Trusts are Not Foreign Trusts for Tax Purposes

On June 6, 2013, the IRS issued Revenue Ruling 2013-14, in which it found that Mexican Land Trust (“MLT”) arrangements were not considered to be foreign trusts.  A U.S. person that owns an interest in a foreign trust is generally required to comply with certain U.S. federal tax reporting requirements by filing the Forms 3520 and/or 3520-A.  Based on Rev. Rul. 2013-14, a U.S. person that owns Mexican real property through a Mexican Land Trust would not generally be required to file the Forms 3520 and/or 3520-A with respect to the MLT.

U.S. persons are generally prohibited from directly holding title to residential real property in certain areas of Mexico.  However, U.S. persons are allowed to hold residential real property located in the Mexican restricted zones if the property is held through a Mexican Land Trust with a Mexican bank.  In order to own the property, the U.S. person must obtain a permit from the Mexican Ministry of Foreign Affairs.

In Rev. Rul. 2013-14, the IRS ruled that a Mexican Land Trust arrangement was not classified as a foreign trust under three fact patterns:

1. In Situation 1, a U.S. citizen owned 100% of a U.S. limited liability company.  The single member LLC was a disregarded entity for U.S. federal tax purposes.  The LLC obtained a permit and signed an MLT agreement with a Mexican bank to hold Mexican real property. The LLC negotiated the purchase of the Mexican real property directly with the seller.  At the settlement, the seller transferred legal title to the property to the Mexican bank subject to the MLT agreement.  The LLC had the right to sell the property without permission from the bank.  Upon the request of the LLC, the bank was required to grant a security interest in the property to a third party such as a mortgage lender.  The LLC was responsible for payment of all liabilities related to the property including Mexican property taxes.  If the property was leased, the U.S. individual would be required to report the rental income on the U.S. federal income tax return.
2. In Situation 2, the facts are the same as the first, except that the U.S. individual owns a corporation instead of a single member LLC.
3. In Situation 3, the facts are the same except that the U.S. individual does not own a separate entity.

Rev. Rul. 2013-14 includes a caveat that an MLT could be classified as a foreign trust if the Mexican bank holds title to any assets other than the Mexican real property, or if the bank is permitted to engage in any activity other than holding legal title to the property.

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