A gain is when an appreciating property you own, like a piece of real estate, a share of stock, or a bond, increases in value above what you paid for it. What you paid for it is called your “basis.”
The gain can either be unrealized or realized. It’s unrealized until you sell it and once you do, it becomes realized.
For most U.S. taxpayers, realized capital gains on assets that you’ve held for more than a year (so called, long-term capital gains) are taxed at a rate of 15%.
What’s controversial is that the income you would normally use to purchase such assets has already been taxed. So, it doesn’t seem fair for the government to tax your earned income and then tax you again on gains from the prudent activity of saving part of that income, rather than just spending all of it!
Now there are loopholes you can use to avoid paying tax on capital gains, such as 1031, or a like-kind, exchanges, the resident home exclusion, selling assets within an IRA or 401K, and so forth.
How about real estate you own in Costa Rica? If you sell it and realize a gain, is it taxable?
Well, yes, if you are a U.S. citizen you would have to report this gain just like any other. Remember, the U.S. taxes you on your worldwide income, no matter where it is generated.
Costa Rica, on the other hand, has no capital gains tax. There is no such tax as long as the gains were not derived from the operation of a real estate business, like being a developer and selling lots from your inventory.
So, you would be taxed in the U.S. on the sale of your Costa Rica property, but not in Costa Rica.
Is there a way to avoid the U.S. tax? Why certainly! If you hold the real estate in a Costa Rican corporation, rather than in your own name, then the gain would belong to the corporation and not to you.
Since Costa Rica has no capital gains tax, the corporation would not be taxed on this gain!
Now, if you withdraw the gain from the corporation in a taxable form, then you would be subject to tax in Costa Rica and potentially subject to tax in the U.S. as well.
However, the Foreign Earned Income Exclusion could come to your rescue, if you qualify, and allow you to escape any U.S. taxation on that income.
Note, however, for this exclusion to apply, the income would have to be drawn out as earnings, such as a salary, and not in a passive way, like a dividend.
For instance, you could buy, sell, and reinvest within a Costa Rican corporation, thereby gradually building wealth over time, without ever having it taxed in either the U.S or Costa Rica!
That would make your Costa Rican corporation a nice tax-free engine of wealth creation, sort of along the lines of an IRA or 401K, but without the morass of regulations, nor the forced taxable withdrawal requirements applicable once you reach what Uncle Sam considers your “retirement age.”
The absence of a capital gains tax in Costa Rica is another reason the country has been very popular among Latin American countries for Foreign Direct Investment.
As always, the complexity of all these taxation rules is well beyond the purview of this short blog post and you should seek the advice of a qualified tax professional for your particular situation.
What Do You Mean, Costa Rica Has No Capital Gains Tax?
Article/Property ID Number 5902
Are you into beautiful Costa Rica?
All interesting things you want to know about Costa Rica are right here in our newsletter! Enter your email and press "subscribe" button.