Introduction and Guest Background
[Richard Bexon] Awesome. Good morning, Alex. How are you doing?
[Alex McGowin] Hey, Richard, doing great. How are you? Good, good.
[Richard Bexon] I know you were, you were in Costa Rica last week and we weren’t able to connect as I’m here in Manuel Antonio, but, but yeah, how was it?
[Alex McGowin] Yeah, that was my first trip really outside of Guanacaste, which was cool just because I’ve spent a lot of time in Guanacaste in the past. So that was, that was a good, you know, different change of scenery, like seeing some of the mountains. And I took the, I guess I flew to Liberia and then did the, and then I was in Guanacaste for a couple of days and then I took the Sansa flight across, which was cool.
Cause then you kind of got to see all the jungle and everything along the way, but yeah, it was fun.
[Richard Bexon] I think I must be one of Sansa’s biggest clients, to be honest with you. So I fly constantly, fly constantly with them, but I’m glad I did it. Yeah.
I mean, you saved yourself a lot of time.
[Alex McGowin] Yeah, it was a lot cheaper. And then some, whenever I’m in Costa Rica, for some reason, I tend to make long drives twice as long as they’re supposed to be. I’m not sure why I have a knack for, for going the wrong direction sometimes.
But, but yeah, so got me there. Awesome.
Current Investment Trends in Costa Rica
[Richard Bexon] Well, let’s get straight into the podcast here. Cause I know that we’ve got some interesting questions, but I mean, you know, volatility continues to happen. I don’t think that that’s going away.
You know, I mean, market goes up, market goes down and just politically, you know, I said the world economics is pretty, you know, and politics is pretty unstable at the moment, but what are you seeing? I mean, cause again, you have clients here in Costa Rica, a lot of your business, but what are you seeing happening here in Costa Rica? And like also how has this impacted your workload?
Like, you know, I’m trying to give the listeners an idea of like, look, I am busier than I’ve ever been or no, I’m not, you know? Yeah. So yeah.
[Alex McGowin] Yeah. I mean, I’ve been, I’ve been working with clients in or investing in Costa Rica now for, for several years. And I feel like as far as the amount of American investment, from my perspective, that hasn’t really changed, or I haven’t seen a downtick in it.
I will say it’s been a little different. I think there were more expats several years ago, but people actually moving there and investing and living there. Now I’m kind of seeing more just investment in say rental properties or, investment properties down there and maybe, you know, part-time, you know, vacation type investments down in Costa Rica.
And that could just be a result of, of less like actual the economics going on in Costa Rica and more just my client base, but that’s what I’ve been seeing. Awesome. Awesome.
Yeah.
US Tax Reporting Requirements for Costa Rican Properties
[Richard Bexon] Well, let’s, let’s get into, you know, some of the details here, because again, I know I’ll probably, you know, I mean, anyone that’s listened or read the description for this, it’s going to be about tax, but like, you know, I mean, I think it’s, I know the answer to this question, but I’m going to ask it anyway, but like if as a US citizen, do they need to report their Costa Rican property or business interest to the IRS?
[Alex McGowin] Yeah. So, I mean, yeah, that’s, that’s step one from a compliance standpoint is just understanding this worldwide tax system that the US tax system has, you know, if you’re a US citizen or a US tax resident, meaning you’re living there or have a green card, then you have to report your worldwide assets. So if you, if you invest in a Costa Rican property, that’s reportable if it’s producing income.
So if it’s a rental property, then that’s going to be reportable to the US. If you just invest directly in real estate and you just hold it, say you have a second home down there, there’s nothing to report to the US actually, if it’s in your personal name, where it starts to get tricky with the reporting is when you start setting up companies in Costa Rica, you have bank accounts in Costa Rica. And of course, when there there’s a business activity through those, through those investments.
Costa Rican Bank Account Reporting Requirements
[Richard Bexon] So, I mean, I think you, you know, I understand like if you have a vacation rental down here as kind of an investment, you know, you need to report that to the IRS, but I mean, if you’re living down here, you have residency, you have your house down here, but the moment you open a bank account, you now have to report that bank account and the money that’s in it to the IRS.
[Alex McGowin] Correct. Well, there’s a threshold limit. So there’s a $10,000 limit.
So once you hit $10,000 US dollars, so then you have to report that on what’s called an FBAR, a foreign bank account report to the IRS. And the way that calculation is done is it’s in aggregate. So like if you have three Costa Rican bank accounts and one of them has the equivalent of $11,000 and two of them have zero, you have to report all three of them because in aggregate it’s, or you add them together.
You know, if you have two accounts with 6,000, you would add them together. You’re over 10,000, you have to report it. So yeah, that’s how that works.
And there’s no tax associated with it. It’s not that big of a deal to do it. You know, people like me can do it.
I show a lot of my clients how to do it online. Cause it’s not, it doesn’t take, you know, a rocket scientist. It’s more just knowing you have the reporting responsibility because the penalty can be high.
It’s technically $10,000 per year. Wow. So you can very easily start getting to penalties that are more than the value of the accounts, you know, which is a little ridiculous, but.
FATCA and International Banking Compliance
[Richard Bexon] Yeah. I mean, but also, you know, I’ve been, I’ve been opening accounts here recently and some of my investors or, you know, shareholders in this stuff are actually us citizens and I have to actually have to fill out an IRS form here. You know, when opening a corporation bank account here and they want to know, you know, the shareholders, their names, their social security numbers, et cetera.
So it’s being reported.
[Alex McGowin] Right. And that’s a good point. I mean, there’s really two sides to the foreign bank account report or the Costa Rican bank account reporting.
One is the reason all this came up is under what happened under FATCA, the foreign account tax compliance act back in 2000, I forget, 11, 12 or 2010 actually. And what they did, the IRS basically blackmailed the rest of the world. These are my words, but blackmailed the rest of the world’s banking system to say, you’re going to turn over all of your U.S. account holders to us, the IRS, or we’re going to charge you a 30% tax on any transaction with the U.S. financial system. So this makes Costa Rica being one of them signed up. And so to do that now they want to know they have to send, put in a form to ask if you’re a U.S. person when you sign up, sometimes that makes them say, we don’t actually want you. That’s too much paperwork.
And they kick you out. I haven’t seen that as much in Costa Rica.
[Richard Bexon] No, I haven’t seen that.
[Alex McGowin] As I’ve seen in other countries. But so the financial system or the bank in Costa Rica has to file a report with the IRS or the U.S. treasury to disclose the U.S. account holders and their financial accounts. You’re doing the same thing on your side to the IRS.
[Richard Bexon] Well, they’re just checking, right?
[Alex McGowin] Well, they should be, but they actually haven’t figured out how to match the two yet. So there’s no, like I said earlier, there’s a $10,000 penalty. In my experience, it’s extremely unlikely that you, I mean, just being honest that you’re going to get caught now.
But it’s so, I feel like they’re so close to being able to match those things that it’s really just a matter of time. And the problem is, is that just the way the format of the information the bank sends is different enough from the format that you send in to make it complicated to match it up, basically, is the problem.
[Richard Bexon] Well, I mean, I’m sure AI could probably do it pretty quickly if that makes sense. So that’s the thing, I think.
[Alex McGowin] The funding question at the end of the day. It’s just, do they have, when do they have the money to invest in the technology to do it? That’s it.
And is it worth it from an investment versus financial benefit? And so at some point, they’re going to make that decision.
State Tax Implications for Costa Rican Investments
[Richard Bexon] I mean, I think we’ve talked at like a government level here, but what about at a state level? Are there any tax implications people should be aware of?
[Alex McGowin] Yeah. So I mean, I’d put at a state level, two different camps, really. One is your people that are staying in the US and staying in their state.
Then nothing really changes. If you invest in Costa Rica, you have, the FBAR and the foreign bank account reporting, that’s strictly a federal thing. That’s not a state thing at all.
But from an income perspective, you’re going to report your worldwide income to the state that you’re a resident in. So that doesn’t really change. If you have rental income or capital gain in Costa Rica, you’re going to need to report that at the state level.
Federally, if you’re living in that state federally, you get a credit for income taxes you pay in Costa Rica on your federal tax return. At a state level, that may or may not be true depending on what state you live in. For example, Maryland does not allow the foreign tax credit.
California is a little tricky. California is always tricky and expensive. New York doesn’t allow foreign tax credit.
So it really just depends what state you’re in. You have to look at the specific rules. But then the other side of the coin is if you actually move and live in Costa Rica, I’m generally helping my clients make sure they break residency in whatever state they were in.
There’s no longer any state tax reporting. You can get in a weird situation where if you’re intentionally going to Costa Rica temporarily, so if it’s like you’re saying, I’m going to move to Manuel Antonio for one year and then we’re going back to Idaho, you’re going to continue to be an Idaho resident under their domicile rules even for that year. But otherwise, we’re breaking residency and losing a taxing jurisdiction if you’re moving.
That’s the goal.
Best States for Foreign Income
[Richard Bexon] What are the best states to be a resident of then if you have a foreign income?
[Alex McGowin] Generally, the non-taxable ones. So that’s going to be Florida, Texas, Nevada, Washington, South Dakota. I’m probably leaving out a couple, but those are your non-tax states, at least no income tax.
Those are generally the best. And then other than that, I guess I define it more by what’s the worst. And it is kind of what you’d expect.
California, Illinois, New York, those are the ones that have the highest rates and they’re more complex in their administration. So yeah.
Maximizing Tax Deductions on Costa Rican Real Estate
[Richard Bexon] So I was with an investor the other day. He was looking at property down here with me to do another investment. He was taking pictures of everything going on, getting bills for everything.
He already has a company here in Costa Rica. And I think that what he was doing was showing evidence in order to be able to maximize some form of deductions he has, that he can deduct his travel, he can deduct his expenses while he’s down here, while he’s looking for his next investment. I don’t know whether that was the right way to do it or what he was doing, but how do you maximize your deductions in the US on Costa Rican real estate investments, vacation rentals?
[Alex McGowin] Yeah. I mean, the first step with deductions is making sure you have a trader business. So if it’s a passive investment, like if you invest in a company in Costa Rica or the goal, like you invest in a development project, it’s harder to deduct things in that case, because you don’t have a trader business personally in that state, I mean, in Costa Rica relative to that income.
Rental income is different because that is a trader business that’s going on. So there we can deduct things that are ordinary and necessary. So there’s the typical expenses, like if you have a rental property, utilities, if you’re paying interest on a mortgage, the upkeep of the home is going to be obviously deductible.
But travel is a big one that people leave out a lot of times and it’s tricky the way the IRS defines the travel expenses. So technically to deduct a travel expense, the primary purpose of the trip to Costa Rica would need to be related to that business activity, so that rental property. So as long as the primary purpose is that, then you can deduct all of the travel expense.
So all of your airfare can be done and the rental car, that can all be deducted against that activity. And your stay can be deductible towards the percentage that’s related to the business. So example, and where it gets tricky obviously is determining what was the primary purpose.
And that’s probably what your client was doing. Like what I tell my clients, I have kind of a workbook I give people to document what they’re doing each day. And it’s not done by like hours, because if you go to Costa Rica for a week and you’re going to meet and look at investment properties and things like that, or maybe just check on an investment property you have and restock things, buy things, it’s not that you necessarily have to spend more time doing that than you do like a leisure activity.
It’s a combination of that and would you have even gone if it wasn’t for the business property? Even though you’re spending more time maybe at the beach, it doesn’t necessarily mean the primary purpose wasn’t the business activity. But what I like to do just from a safety perspective is to kind of document something.
I would rather have more days documented that have some business activity. So that’s probably what your client was doing. What I would say is like each day document like what you did related to that business.
And so it helps you to argue that that’s why you were there. You did some other stuff, but that’s why you were there.
Depreciation and Capital Improvements
[Richard Bexon] And are there any other, like can you deduct anything else, depreciation, anything like that?
[Alex McGowin] Yeah. I guess one thing on that travel too, is there’s two ways. If you have an existing rental property and you’re already available for rent and you’re renting it out, that’s where those travel expenses are directly deductible against that rental activity.
If you’re searching for properties or if you found one and you’re going down there to meet with your lawyers and set up utilities and things like that, but there’s still work to do. It’s not available for rent yet and you need to, or maybe you’re in the middle of construction. That cost is not deductible today.
It’s capitalized as an additional cost to the property. That’s where depreciation comes in. So if you purchase a property for 300,000 and you’re going to spend another 100,000 with improvements and you go down there to manage those improvements, your travel expenses in that case are added to that cost basis of, in my example, 100,000.
And then the general rule is you can depreciate that over 30 years. Yep. So, and that’s a deduction.
Straight line over 30 years, basically. Straight line over 30 years. And technically you have to separate the building from the land.
So, and so the land piece is actually not deductible.
[Richard Bexon] So you can’t appreciate the land, but you can appreciate the construction.
[Alex McGowin] Correct. You can depreciate physical building, but not the land. So, I mean, and usually it’s not that straightforward to figure out what’s the value of the land versus the building, unless you bought the land and then put the building on, then it’s obvious, but otherwise you take a reasonable approach to split the two.
[Richard Bexon] Can you deduct food while you’re here as well?
[Alex McGowin] Yeah. So that’s, then you get a 50% deduction related to that.
[Richard Bexon] Okay.
[Alex McGowin] One of the things with depreciation too, is there’s different classes. So like the building is a 30% class. So that’s straight line over 30 years, but things like furniture and- Fixtures and fittings.
[Richard Bexon] Yeah.
[Alex McGowin] Fixtures and fittings. That can be five or seven years. So one thing you can look into is what’s called a cost segregation study to, you know, I guess the simple way is just to say, all right, my building, I spent 300,000 of it.
Let’s say 10% is the land. So we’re going to say 270 is depreciable over 30 years. Well, you can take that 270 and then say, all right, well, I spent another 50,000 on fixtures and fittings and you can break that out.
And then that’s a seven-year property. So that’s boosting the deduction on the front end. What you don’t get that a lot of US people get tripped up by is bonus depreciation.
So in the US, the cost segregation study is a lot more valuable for a US property because when you start breaking it out into these five, seven-year property, you can deduct a hundred. Well, today it’s actually 60% of that. And again, also the other thing about this is that this is one of the areas that the rules change like every year with depreciation.
And this is kind of a hot year, obviously we’re in the middle of a tax reform or tax extension package now that the house has passed and we’re waiting to see what the Senate does. But yeah, depreciation is a big one. The rules change a lot, but the more we can get to lower depreciation numbers, the better.
Capital Gains and Like-Kind Exchanges
[Richard Bexon] Yeah, no, I agree. I agree. Let’s talk capital gains a little bit here as well, because again, from what I understood, and again, this is what I understand.
I mean, if you make a gain outside of the US and you then don’t repatriate it back, but you continue to invest it, it’s not taxable at capital gains in the US. Is that correct or not? Like if there’s an actual sale that triggers- Well, I mean, I bought something for, I don’t know, 500,000.
Five years later, I sell it for a million. There’s been a gain, probably a little bit more depreciation, but say that gain that I have, if I now go and buy another property for 1 million in Costa Rica, there’s no taxable event on that gain, if that makes sense, in the US at the moment. Or is that wrong?
[Alex McGowin] Well, it’s possible you can get there. It doesn’t automatically- Okay. Okay.
Okay. That’s the point.
[Richard Bexon] So you can- Because you can keep rolling it in the US, right? You can just- Right.
[Alex McGowin] Yeah. There’s a like-kind exchange or a section of 1031 exchange where in the US, you can defer the gain on business property that’s of a like-kind. So for example, investment property, rental properties, yes, you can sell those.
And in your example, if you have this gain, you can turn around and purchase another investment property and roll that gain into the other property. So a simple example of how that would work is if you purchase a property for 100,000, it goes up in value to 300, you sell it, make a $200,000 gain. And then you go buy another property for 300,000, you now have to reduce your basis in that property by the 200 gain that you before went, if that’s a word.
[Richard Bexon] Yeah. I mean, you’re deferring it, right?
[Alex McGowin] You’re deferring it.
[Richard Bexon] You’re going to have to pay it at some point. You’re just deferring it.
[Alex McGowin] Exactly. But there’s very specific rules for how you apply that like-kind exchange. You have to locate the replacement property within a certain amount of time.
And most importantly, you have to use a qualified intermediary in the U.S. Meaning you can’t personally like sell that property, take the money and go buy another property. You have to sell that property. It has to go into escrow with a qualified intermediary that you connected with on the front end.
They hold the money and they purchase the property. It’s a very specific set of events that have to happen. So if you wait until after you’ve sold the property and taken the money, it’s too late.
Controlled Foreign Corporations and Repatriation
[Richard Bexon] But what happens in Costa Rica? Let’s say in Costa Rica that you do something like this. If you don’t repatriate that money, when is there a taxable event?
[Alex McGowin] If you don’t repatriate it?
[Richard Bexon] I mean, you don’t bring it back to the U.S. I mean, it just stays in Costa Rica, if that makes sense.
[Alex McGowin] Oh, yeah. I mean, if you don’t, like if you sell a property and you leave it in a personal Costa Rican bank account or even a business bank account, that’s a realized gain in the U.S., regardless of whether you actually take it back to a U.S. bank account or not. The U.S. doesn’t care about the repatriation aspect. The exception to that is if it’s owned in a Costa Rican corporation. So that’s where it can get a little tricky. So if you own an investment property through a Costa Rican corporation, the way it’s taxed in the U.S. depends on whether that’s a controlled foreign corporation or not. So if you own 100 percent of it as a U.S. person, it’s a controlled foreign corporation and it triggers potential anti-deferral rules. So what you described was the concept of deferral. You sell it and you don’t have to pay tax until you bring it back.
That’s the way it should work. But the IRS has certain rules when you control a foreign corporation to where they don’t allow that deferral, make you pick up the income anyway. But if you own it with other Costa Ricans or if you have it 50-50 with a non-U.S. spouse, it’s no longer a controlled foreign corporation. So it triggers that default rule, the deferred rule. So in that case, if it sits in the Costa Rican corporation, it’s not taxable until you repatriate it or take it out as a dividend or stock. So that is a possibility, but it depends on how you’re structured.
Optimal Ownership Structures for Costa Rican Properties
[Richard Bexon] Yeah, yeah. Because I was about to ask you, if I have a vacation rental down or investment property, is it better for me to hold it in my name or is it better for me to hold it in a corporation?
[Alex McGowin] Yeah, I mean, I generally say in your name or in a corporation, even if it’s in a corporation, I do what’s called an entity classification election to make it a flow through. So one thing to be careful of in the U.S. is a lot of times you’re going to set up the Costa Rican equivalent of an LLC, the SRL or limit dollar. And the U.S. is going to treat that as a foreign corporation, even though, like in my mind, if you’re a U.S. person is going to think an LLC defaults to a flow through in the U.S. It doesn’t default to that in Costa Rica. So I mean, generally, I like to make the flow through election on typical rental properties just because you get to retain the capital gain treatment. So the problem with selling it, keeping it a foreign corporation is that you may be able to defer the gain on the sale. And that only happens if it’s even if it’s a controlled foreign corporation.
If you pay more than like a 20 percent tax, actually, 19 percent tax in Costa Rica on the game, which I think you would in most cases.
[Richard Bexon] No, actually, capital gains in Costa Rica is 15 percent.
[Alex McGowin] Okay. So in that case, it’s going to trigger the anti-deferral rule. So you don’t get the deferral and then you get taxed at ordinary rates.
So two bad answers. So whereas if you had the flow through, it’s going to be taxed at capital gains, which is going to give you, in some cases, half the tax rate. So it’s a much better answer.
So I like the flow through holding it directly model unless we can get out of the controlled foreign corporation rule. So 50 percent spouse, Costa Rican investor, some way it’s not a U.S. controlled foreign corporation.
[Richard Bexon] Interesting. And a flow through basically just means that all basically income and expenses flow up to a U.S. Corp or flow up to you personally in the U.S. Right.
[Alex McGowin] Whoever owns it in the U.S. So if you own it personally in the U.S., it’s going to flow up to you. The annual income and expenses, but also the annual Costa Rican tax. So, I mean, if it’s a rental property and you make, you know, $10,000 on that property, you’ll take a credit for the Costa Rican taxes paid.
Yeah. So you’ll pay the higher of the two at the end of the day.
[Richard Bexon] Wow.
[Alex McGowin] OK.
[Richard Bexon] You pay the higher of the two taxes. Correct.
[Alex McGowin] Yeah.
[Richard Bexon] Wow. I think Costa Rica probably tax rate might be a little higher than the U.S. depending on how much your revenue is.
[Alex McGowin] Probably so. That’s been my experience. So in a lot of cases, plus when you add factor in the depreciation we mentioned, in a lot of cases, there’s not any income, you know, so I like the flow through model personally.
And it’s just important people know that doesn’t happen automatically either. You need to make the election technically within 75 days. But yeah, it’s fun stuff.
Thanks Noah.
Personal Investment Preferences in Costa Rica
[Richard Bexon] Well, I mean, look, if they made it easy, they wouldn’t need you, Alex. So, you know, but, you know, I always say that, you know, if it was easy, everyone would be doing it. And I mean, I suppose, you know, that applies to most things.
And, you know, because people are like, Rich, I don’t know. You know, I was talking to someone the other day. They were like, Rich, do you realize how much more money you could be making if you’re in the U.S. or, you know, in the U.K. developing or Europe? And I’m like, yeah, but it’s not as fun, man. Like I get to, you know, build cool stuff down here and work with amazing people. And we have great investors, you know, so.
[Alex McGowin] I get to tell my wife I have to go to Costa Rica for work, you know? I mean, yeah, exactly.
[Richard Bexon] You do deduct those travel expenses, right?
[Alex McGowin] Oh, yeah, yeah, for sure.
[Richard Bexon] OK, OK, OK, OK.
[Alex McGowin] I know the rules, you know.
[Richard Bexon] Well, Alex, this has been, you know, this has been great, man. I mean, I could go down the rabbit hole with you, and I’m sure that there’s probably more, you know, questions here from people listening here. So I’ll put up your contact details in the description.
But my last question for you, Alex, which is one I love to ask, you know, every single time, and I’m not too sure. I don’t remember what your last answer was, but, you know, it kind of changes every single time sometimes, you know, that I speak to people. But if you inherited $500,000 and you had to invest it into a business or real estate in Costa Rica, what would you invest it in and why?
Investment Focus: Central Valley and Escazú Area
[Alex McGowin] Yeah, so I would say I can’t remember what I said before either. But now that I’ve seen another part of the country, like I was kind of very like, you know, headset on on the beach in Guanacaste. Now I’m really liking the jungle area and like heading out towards San José.
So, yeah, I would want, you know, for me, for me personally, it’d probably be like a personal place that I could go in Costa Rica. And so, yeah, I’d like to see, you know, maybe in that Escazú area or like some like farmland out there somewhere that has, you know, great weather.
[Richard Bexon] I mean, look, the city continues to grow out. You know, I mean, land prices when I came to the country 20 years ago to where they are today in the Central Valley is just insane, the difference, you know, and it keeps moving west, you know. So, I mean, I think farmland out there, you’d probably do pretty well with.
And again, we have great infrastructure here in the, you know, the Central Valley or I’m not there in the Central Valley. I live there. But like, yeah, but like, I mean, that’s a very interesting one because we’ve got a lot of people looking at like San Ramón and Grecia and even Ciudad Colón Escazú at the moment as investments, because also is, you know, and we see a lot of development, a lot of free trade zones moving out there as well from people from the U.S. And like all this foreign direct development that’s not happening in the beach is happening in these areas.
[Alex McGowin] Right. Yeah. No, I really enjoyed that area.
And it’s closer to the beach than I thought. Like, I mean, you can get to Jacó in an hour and a half from where I was, you know. So, yeah, it’s a really cool spot.
I think that’s where I’d be looking.
[Richard Bexon] Awesome, man. Well, Alex, it’s been an absolute pleasure. Thank you very much for, you know, sharing all of your knowledge with us and anyone that wants to get in contact with Alex, I’ll put all of his contact details in the description.
But very much appreciate it, sir. All right. Thanks, Richard.
[Alex McGowin] Appreciate it. Always. Have a good one.
[Richard Bexon] See ya. Bye.
