Finding a fideicomiso (Mexican Land Trust) similar to the Illinois Land Trust described in Revenue Ruling 92‑105, in PLR 201245003 the IRS ruled that for federal income tax purposes such an entity is not to be treated as a trust as that term is defined in Reg. §301.7701-4(a) and that the beneficiary of the trust is treated as the direct owner of the trust.
Due to specific requirements under Mexican law and provisions in the U.S. Internal Revenue Code, advisers with clients that owned property along the coast in Mexico have been concerned for years that the their clients may need to file a Form 3520 when the property is acquired and a Form 3520-A each year thereafter, or face significant penalties.
Under the Mexican Constitution, individuals who are not citizens of Mexico are prohibited from directly owning real property located within 100 kilometers of Mexico’s inland borders or 50 kilometers of its coastline. Thus, a non-citizen of Mexico looking to acquire an interest in such property instead officially purchases beneficial interests in a Mexican Land Trust (the fideicomiso) which holds title to the property in question.
Under IRC §6038 foreign trusts in which U.S. citizens hold interests generally must file certain information with the IRS, including Form 3520 on formation of the trust and Form 3520-A annually to report information about the trust. Significant penalties apply if such forms are not filed timely when required. Under IRC §6677 penalties for failure to file the Form 3520 upon transfer of assets to the trust are set at the higher of $10,000 or 35% of the value of the property transferred. If a Form 3520-A is not filed when required, the penalty is the greater of $10,000 or 5% of the value of the trust assets treated as owned by the foreign person at the end of the year.
IRC §7701 is the Code’s broad definition section, and its definitions apply for all purposes under the IRC unless a provision specifically provides for a separate definition. Reg. §301.7701-4(a) provides specific definition of what constitutes a trust for purposes of federal taxes.
In Revenue Ruling 92-105 the IRS concluded that an Illinois Land Trust was not a trust for federal income tax purposes, as the trustee’s only duties were to hold and transfer title at the direction of the beneficiary. Thus, the Illinois Land Trust was a mere agent for the holding of property, and the property was treated as being owned directly by the beneficiary of the trust.
The letter ruling concludes that the fideicomiso serves the same purposes and is, therefore, not a trust for federal tax purposes. The ruling notes that the trustee merely holds the title to the property and transfers that title at the direction of the beneficiary. The trustee has no duty or right to defend, maintain or manage the property, with all rights retained by the taxpayer/beneficiary. Thus, the fideicomiso is not a trust.
While the ruling does not directly mention the reporting requirements under IRC §6038, such reporting applies only to foreign trusts and if the entity is not a trust no reporting would be required.
Some caveats should be noted—the ruling does indicate at the very end of its analysis of the law and facts that there was no arrangement among the trustee, the owners or any other person to use the property in an activity for a profit such that ownership could be classified as a business entity. However, it seems more likely that such an arrangement would not create a foreign trust, but might create an entity with other reporting arrangements (such as a corporation, partnership, etc.).
As well, the ruling is a private letter ruling and, technically, can only be relied upon by the taxpayer that requested it. Other advisers will need to study the support behind the IRS’s finding and determine if the wish to adopt that logic. Nevertheless, it seems the IRS National Office has decided it would prefer not to face an avalanche of information forms related to such (often vacation) properties.
