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186 Understanding US and CR Tax with Alex McGowin

186 Understanding US and CR Tax with Alex McGowin
186 Understanding US and CR Tax with Alex McGowin

Podcast Transcription

[Richard Bexon]
Good afternoon, Alex. How are you doing?

[Alex McGowin]
Hey, Richard. Good afternoon. Doing well.

How are you?

[Richard Bexon]
Yeah, good, man. I really appreciate you taking time out of what I'm sure is a busy day to talk tax with us, which everybody loves, of course.

[Alex McGowin]
Yeah, of course, especially this time of year, right?

[Richard Bexon]
Exactly.

[Alex McGowin]
At least in the U.S. tax world.

[Richard Bexon]
Well, I mean, my first question is just kind of get a real gauge of kind of what you're seeing happening. I mean, you know, 2023 was a year that we were getting used to interest rates, you know, people trying and inflation markets seem to have stabilized a little bit here in the first two months of 2024. But I mean, how was the volume of people inquiring on your side and also your work being Q1 so far compared to 2023?

[Alex McGowin]
Yeah. Yeah, I would say it's been stable and increasing. I mean, obviously, my world, most of what I do is individual expat related.

So U.S. people living outside the U.S. or at least investing outside the U.S. And, you know, that had a big boom right after covid when people all of a sudden it used to just be people who had jobs that allowed them to work outside the U.S., but now all of a sudden people could go anywhere and work remotely. And that was a big boom. But I expected that to taper off some.

And it really hasn't. I mean, economically, you know, people have continued to invest outside the U.S. and Costa Rica in particular has been a hot spot for a lot of reasons. But yeah, from my experience, the inquiries have gone up and people are still moving around buying things and needing tax advice.

[Richard Bexon]
Well, I mean, look, once you're crossing borders and you have funds crossing borders backwards and forwards, you know, I mean, it's you're dealing in two tax jurisdictions and how they talk to each other and how they shake hands or how they don't in some areas. So I'm sure it can be very complicated. I mean, what are some of the common questions you get asked if you don't mind me asking, Alex?

[Alex McGowin]
Yeah. Yeah. I mean, and it is complicated with two different with countries when you're dealing with both countries in particular and with the U.S. in particular, just because they're, you know, have a citizens based taxation scheme, which is what makes it more complicated from X for expats. But it's one of those things where it's you don't know what you don't know, where at the end of the day, it's usually not that complicated as long as you're going down the correct road, I guess. But, you know, the common questions I get are, you know, I kind of have two different extremes of clients. You know, I have the people that are.

Because, I mean, an expat could be somebody who just moved outside the U.S. for the first time or somebody that's literally never been to the U.S. and they're going to have a totally different mindset as to how they feel about the IRS and and how aggressive they want to be. I mean, you know, you have people that are literally moving to try to avoid tax. And then I have other people who are moving to, well, you know, very nervous that they're not going to do everything correctly.

So, most people fall somewhere in the middle. And generally with those type of people, the questions are, what do I need to report? Say, if I invest in, if I move outside the U.S. or I invest in a foreign corporation, a foreign investment property, what are the forms that I need to report so that I don't get penalized unnecessarily by the IRS? And how do I not pay more taxes than I need to? And that's kind of the lane I try to stay in and keep most people in is, you know, don't get in trouble, do things correctly, but also don't pay more taxes than you need to. And those are the general questions.

[Richard Bexon]
I mean, you know, I mean, I'm sure that you look at it, you know, there are some things that being an expat, there's a benefit for as well. I mean, you're not a resident of the U.S., but you've got a U.S. passport, I believe that there's a benefit, you know, when you're not living full time in the U.S. I mean, what are some of those things that you think that, you know, people can use or should be using?

[Alex McGowin]
Yeah, for sure. I mean, you know, the first goal is to make sure you're not paying taxes twice in both countries, but there's also benefits, like you mentioned. And the main one that I use with people that are that have earned income, so salary income or self-employment income is the foreign earned income exclusion, which allows you to exclude up to 120,000 of U.S. dollars, 120,000 U.S. dollars of earned income per year, assuming you meet certain tests. And basically the basic test is you have to live. So your tax home where you live and work needs to be outside the U.S. for 330 out of 365 days. So you can spend about a month in the U.S. and still qualify for this foreign earned income exclusion, which is a pretty good deal, especially if you're looking at countries that have low tax rates or no tax rates, you can completely avoid tax altogether on that 120,000, which is a pretty good deal. And then there's also more complicated structuring alternatives with foreign companies and trusts and things like that. That just kind of depends. It's very situational as to how that works.

[Richard Bexon]
I mean, let's switch gears into kind of real estate a little bit or property. I mean, is it better for me to own property in a foreign country? Let's say use Costa Rica as an example, in my name or in a company name from a tax perspective.

[Alex McGowin]
Yeah. So it depends. It's always the best accounting answer.

It depends on the motivation behind the property. Like, for example, I talked to two different clients this week, both of them in the U.S. and investing in a Costa Rican property. And generally people are coming to me after they've already done everything, right?

So then it's kind of like, we've done it to fix something, right? But generally there's non-tax reasons for owning it through a company, just like here in the U.S. I mean, generally you own it through US LLC, same thing in Costa Rica or another country. It makes sense for whether it's legal liability purposes or access to banking.

There could be all sorts of reasons, but it makes sense to own through a foreign company. The nice thing in the U.S. is that you can actually choose the way that company is taxed for U.S. tax purposes, whether it's considered a foreign corporation or it's considered a flow through. So it's as if you owned it directly.

So I guess to answer the simple answer to your question is it doesn't really matter, but I would suggest owning it through a company for the non-tax reasons, because we can give you the same tax answer as if you didn't own it through a company. So it cancels those out. But whether you want to treat it as a corporation, a foreign corporation for U.S. tax purposes, or as a flow through, depends on the motivation behind it. And I guess I can give you kind of a brief understanding of the U.S. taxation of each, just so, and how I'd release one client versus the other.

[Richard Bexon]
Yeah, please do.

[Alex McGowin]
Because I had two good examples this week of people that, one, it made more sense to have a flow through type structure, and one, it made sense to have the corporate structure. But the default is a corporation. And there's some exceptions to these rules, but I'm talking about like the standard Costa Rican version of the LLC defaults to a foreign corporation for U.S. tax purposes. So if you do nothing, it's a separate company, none of the income or loss from that property, if it's going to be a rental property, is going to flow up to your personal tax return. So that can be good if there's income, that can be bad if there's loss, because you're not getting the benefit of those losses. But even on the income side, there's anti-deferral rules in the U.S. that are generally going to make you pick up that income anyway. So if you have a foreign corporation, you're most likely going to have to pick up the income on the rental property anyway, or if it was later a capital gain, you'd have to pick that up. And if there's losses, you don't get the benefit of those losses carrying forward. That can be a huge negative.

So like the client I talked with today, I mean, his whole plan is he has a rental property, he's invested in that property and is using that to work towards his residency in Costa Rica. And then eventually he's going to sell that property to buy something where he could live. That's his plan.

And so most likely, if all goes well, he's going to have a big capital gain on that real estate property. So in that case, if he was to leave it as a foreign corporation for U.S. tax purposes, he's likely to, after depreciation, he's going to have losses each year that are accumulating up in that foreign corporation. And then he's going to sell it and have a capital gain in the company that the U.S. is going to tax. And he's going to lose the benefit of those losses. So what I advised is to make an election to treat as a flow through. Now those losses are going to flow up.

It's later going to be a capital gain and you're going to be able to unlock those suspended losses to reduce your income. And so I guess most times it makes sense to do a flow through. When it doesn't make sense is, let's say you're a little bit late in the game and you've already had this rental property for three years.

And now you're wondering if you should make a flow through election. If you make that election after the not right when it starts, then it triggers a deemed sale. So now you've created a capital gain and it's actually a little bit worse than that or a little more complicated than that.

But you've created tax. So at that point, it can be more complicated to make it. So sometimes you want to keep it there.

[Richard Bexon]
I mean, say that I've got a corporation down here I'm using as a vacation rental. I'm making $50,000 profit per year. I'm paying tax here in Costa Rica at a rate of 30%.

So I'm paying $15,000 down here in tax. If that money then flows to my U.S. court, do I get credit for that $15,000 tax? I'm not being double taxed in the U.S. Yes.

[Alex McGowin]
So in a flow through scenario, you definitely do. So if we check the box of what it's called and had it then come flow up to your U.S. return, then you would definitely get the credit in the U.S. If you don't, it depends on who the owner is of that foreign corporation. So if it's a U.S. individual, the general rule is you actually don't get a credit on that dividend coming up. You can make an election that ultimately gives you... I mean, it's just like any other individual owner of any corporation. There's a double taxation involved.

There's the corporate tax and then the tax on the dividend. So as an individual, you're not going to get that credit. If you have a U.S. corporation that owns a foreign corporation, it's actually not a taxable event coming up to a U.S. corporation. It's not until it comes out to the individual. It generally is going to make sense if you're making profit in that company or you're using it as a business. Then if you can make a check the box selection as an individual, it usually makes sense to.

[Richard Bexon]
A lot of people, I hear accelerated depreciation. I deal with a lot of high net worth individuals that love to go out and buy things around tax time in order to accelerate depreciation. Can that be used on foreign assets or not?

[Alex McGowin]
With foreign assets, you have to do it on a straight line basis, unfortunately. So in the U.S., we have all kinds of things. With U.S. assets, we have bonus depreciation, which is constantly up for debate and subject to change in Congress. But we have bonus depreciation, 179 depreciation and the accelerated depreciation. But whenever you have a foreign asset, it's important to understand that it has to be done on a straight line basis. And actually with buildings.

So with a rental property in the U.S., it has a 27 and a half year life. Whereas if it's a foreign property outside the U.S., it's a 37 year life. I'm sorry, it's a 30 year life.

It just changed from 40 to 30 years. So it's not as bad. That changed this year to where it went from, it used to be a 39 year life and then they just changed down to 30.

I'm not sure. I've never understood what could possibly be the reason for that. Like why would a foreign property depreciate slower?

I guess part of it is when you try to apply the logic sometimes to some of these rules, that's where you go astray. But I mean, it's probably some stuff.

[Richard Bexon]
Look, I mean, I get why they would not want to accelerate depreciation or the bonus appreciation stuff down here, because otherwise people are going to want to buy assets outside of the U.S., which takes it out the U.S. economy and the machine doesn't move as fast. I understand that. So it's like if I've got a tax bill at the end of the year, if I could do it foreign or here, like foreign's a little bit more sexier maybe.

So I like that, you know, rather than going to have to buy a yacht or a car or something else, you know.

[Alex McGowin]
That's true. That makes sense. I can definitely understand why they wouldn't do accelerated, but it's hard to justify why the class life, the useful life would be different.

[Richard Bexon]
But you're right.

[Alex McGowin]
That's probably, that is the reason. They want to entice people to invest in the U.S. and not foreign.

[Richard Bexon]
Yeah. Yeah. Wow.

Wow. I mean, it's just great to have someone on the podcast that kind of knows U.S. tax and how that relates, you know, with tax down here. I mean, we get so many questions of like people are like, should I have it in my name or should I have it in a corporation?

And I usually just say I'd have it in a corporation because like it just gives you more protection and liability. But like if you want to fly down here, that corporation can pay for it. Like you have to travel down here, you know, and you can do that from your taxes down here in Costa Rica and you'll stay and your car rental and all of that stuff, because you're coming down here to service your asset.

[Alex McGowin]
Yeah.

[Richard Bexon]
Yeah.

[Alex McGowin]
I mean, where the IRS really gets you, I mean, it it's important, obviously, to structure it correctly from a U.S. tax standpoint to be tax efficient, but also it triggers additional filing requirements in the U.S. that the IRS is extremely stingy about. And I mean, one thing that's kind of crazy about the IRS is, I mean, for example, if you own a foreign corporation, you have to file basically this mini corporate tax return with your personal tax return. And I mean, it's the same form for, I mean, you know, I have a client that's a piano teacher in London.

You know, it makes 3000 pounds a year. It's this and she has it in a limited company. It's the same form as Google has for its multi-billion dollar subsidiary in the U.K. It's same form, same penalty if you do it wrong and same complexity in a lot of cases. I mean, for the piano teacher, it ends up being a bunch of blank pieces of paper, but there's no threshold between like who has to file these things and who doesn't and who gets out of the penalties and who doesn't.

[Richard Bexon]
Yeah. I mean, I always giggled because a lot of my business partners are from the U.S. and when we do stuff, they have to file their taxes and stuff. And they're like, well, Rich, you're not filing taxes in the U.K. And I'm like, I'm a non-domiciled Brit dude. Like I don't file taxes in the U.K. like, you know, so I do it here in Costa Rica. And, you know, and yeah, so it's just and they're like, you're so lucky, buddy. You're so lucky.

You have no idea.

[Alex McGowin]
Yeah. Yeah. I mean, something of all and some I used to teach at a university and the thing I always told people is that there's two countries in the world that tax based on your citizenship.

And it's it's the U.S. and a small African country called Eritrea.

[Richard Bexon]
Yep.

[Alex McGowin]
I actually, for the first time, this was last year, I had a client, I had somebody reach out to me through my website that I spoke to, and they were a U.S. green card holder living in Eritrea. They were they were like the worst. They were they were the worst possible scenario of a no.

No, it wasn't that they were a U.S. green card holder with Eritrea citizenship living in the U.K. So they were taxed by three countries at once because you had two citizenships. The green card is effectively a citizenship for U.S. tax purposes. So I was like, I was like, I don't know what to do.

I have to think about this. You have three foreign tax credits going on. Wow.

But yeah, the U.S. can make things can make things difficult. But like I said, it's kind of just knowing what the problems are. And in most cases, it certainly can be complicated, but in most cases, it's not that bad.

Yeah. But you don't want to be on the wrong side of it, I guess.

[Richard Bexon]
Yeah. I mean, are there any other things that you think people should bear in mind when buying, investing in real estate down in Costa Rica or anything else that they should be doing even before that they buy or they're thinking of buying it? You know, any advantages they can take care of, any questions they should ask, you know, should they have a good accountant down here that then connects with someone like yourself up there?

Like, what's your advice?

[Alex McGowin]
Yeah. I mean, especially especially if you're staying in the U.S. and investing in properties, I find it extremely helpful. And the clients that I have that do this find it extremely helpful to have a good property manager in Costa Rica that actually can provide.

I mean, especially the ones because some of my clients, they don't even need to get a Costa Rican bank account. They do it all through their property manager where they get billed from them. So they don't have to go there.

They get a very clean. And I like this as an accountant where I get a very clean sheet of what was the rental income for the year? What were the expenses?

And they post things for them. If they're doing Airbnb, they can go through their platform. So, I mean, if you're doing a rental property, I would definitely suggest using a legitimate property manager.

But other than that, from a tax perspective, it's asking the questions before you get started, I guess, is the main thing.

[Richard Bexon]
Okay. Well, yeah. I mean, on that property management front, I mean, people just need to make sure it's SUHEV registered, which is kind of like RSEC here, I would say.

It's like a light thing. Okay. I mean, I'm going to say there's pros and cons to having your own bank account and not.

Opening a corporate account here is not too bad. Corporate. Personal, unless you're a resident, nightmare.

The only benefit of opening your corporate account and having the money flow there and then paying your property management company is, if your property management company is not really that well established and doesn't manage its money that well and goes out of business, unfortunately, a lot of the time you lose all your money.

[Alex McGowin]
Okay.

[Richard Bexon]
So, I've seen that happen. There have been a couple of big ones here in Costa Rica, where they were managing like 50, 100 properties and just overnight closed doors and there was no money left. And all client money came into one account.

Whereas the smart ones, and we do this with construction, we make the construction companies open a separate account. So, only client's money flows in and only client's money flows out. So, we can see all the bills coming in and then we can see to make sure that the bills are lined up with all payments out so that they're not, what is it they call, robbing from Peter to pay Paul.

But from that front here is what a lot of them do is have your corporation open it up, the money flows in there, and then the property management company will invoice you to pay. And they still manage your account, but it's a separate account that you have access to and you can review everything happening in that account.

[Alex McGowin]
Yeah. Because honestly, I wasn't really sure how that worked with the property managers where you don't have an account in Costa Rica. Do you front them money that then they hold on to?

Is that what you're saying? And then if they go poof, so does your money?

[Richard Bexon]
Yeah. I mean, look, usually property management companies here will request two, three months of operating expenses in the account when you first start. So, you wire them, I don't know, say $10,000.

Then revenue starts to come in and basically is you get your P&L every single month. As you said, at the end of the year, you've got your P&L says it has 50 grand. You're like, you know what?

I want 40 grand of that. They send it to you. But sometimes people are like, nah, just leave it there.

And it accumulates, man, 200, 250, 300. And actually the smart ones, if they're smart, would take that money and put it into a fixed deposit and make interest on it, or do it on behalf of their clients. Because a lot of businesses, the money is in the money that you hold on to.

Meaning that a lot of businesses sit on tons of cash and they put it into a fixed deposit of 30 days and make themselves a couple of percent. And that's their profit off your money. But anyway, in those circumstances, yeah.

I mean, unfortunately, if they go poof, so does your money.

[Alex McGowin]
So, your suggestion is to have the corporate bank account. You can still use a property manager, obviously, to help you correct.

[Richard Bexon]
You give them access. You just give them access to your money. And you can limit how much that they can transfer in a day and how much they can do in one transaction and that kind of stuff as well.

So it's just a little, it is a little bit more complicated. It doesn't take long to set up, but it just makes sure of that. Like, you know, I always say people come down here, they have, they get off the plane, they smell the air and like they're drunk, dude.

And they do stupid stuff sometimes, or don't ask questions that they would ask, you know, as they typically would do when investing in the US. So, you know, and I think down here, sometimes you need to be even more cautious. So, but anyway, well, my last question for you, Alex, as I've kept you long enough, which I'd love, you know, and I don't know how much perspective you have on this, 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?

[Alex McGowin]
Yeah. I mean, like I said before, as an accountant, it depends on the answer and shoot, I'd probably come to you, Richard, and tell me what to do with my $500,000. But no, I mean, from what I know, from what I know about the economy there and everything, it would probably be real estate just because I feel like it's a safer investment.

Yeah. And I don't know a lot about the business expansion and things going on in Costa Rica, but I know that there's real estate and that's a growing market.

[Richard Bexon]
Yeah. No, I mean, it's a great market if you know what you're doing. I mean, I had a conversation with a client the other day, it was like, look, Rich, I can go out and I can speak to realtors, but I'm not sure I'm going to get a clear picture from everyone of what's going on.

And that's why they hire us. They hire us as consultants, because we're like, I'm not going to let you invest in anything I personally wouldn't invest in. And I'm also going to show you all the risks that are involved as well, as well as a working P&L of what your business could look like down here.

As I always say, I'm the client's pain in the butt on their behalf. So they don't have to be, but they can kind of enjoy it and let me be the pain in the butt. Yeah.

[Alex McGowin]
I mean, I can see it both ways though. I mean, the real estate is there because people are moving there and the people that are moving there, there are services that the service industry in particular needs to expand to meet the demand of the people moving there. So, I mean, yeah, there's opportunities on both sides.

[Richard Bexon]
I mean, you're in one, which is tax across borders. I mean, that's huge between Costa Rica and the U.S. There's a lot of U.S. citizens living down here and they need their taxes done every year and they own businesses and have assets down here and just want to figure out of how the flow of profits, losses, depreciations, capital gains, how that all works.

[Alex McGowin]
Yeah.

[Richard Bexon]
Yeah, for sure. Well, Alex, I really appreciate you taking time to come here on the podcast. I've always wanted a someone that knows tax between the multiple different borders and especially expats to come on.

So, really appreciate you taking the time to come on, sir. Yeah, absolutely. Appreciate the opportunity.

Awesome. Have a good one. All right.

Bye.

Let's Get in Touch!

USA CPA Alex McGowin delves into the intricacies of investing in real estate and running businesses in Costa Rica as a US investor. With expert insights, he guides us through the implications and necessary filings while providing invaluable advice on structuring purchases, leveraging tax codes, and ensuring compliance.

15 minute free consultation: https://meetings.hubspot.com/jake806/crconsult
Contact us: info@investingcostarica.com

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