Should Full Value Be Declared on a Costa Rica Property?

In the process of buying a piece of land in Costa Rica, we get to a point where the client has to make a rather strange decision. Should they declare the full value of the property on the Purchase and Sale agreement? Or should they under declare so that they can avoid paying taxes on the full amount? This may sound like a “shady” decision. One would think it to be illegal to not declare the actual amount paid for the property on their contract. It’s not. In fact, the common practice here for years has been to declare a lesser value and the practice has been embraced by virtually everybody in the country. So, the consideration of “how much to declare” is a feature in nearly all land transactions in Costa Rica.

It is normal to purchase a piece of land using a Costa Rican corporation. In Costa Rica, these are called “Sociedad Anónima” or “Anonymous Society”, or “S. A.” for short. The options for getting one of these is to simply purchase a pre-existing S. A., or corporation, from the attorney who is handling the deal, or to go ahead and have one formed when you first start the process of looking for a property. These take about 3 weeks to form.

Most of the professional law firms in Costa Rica will have a number of “shelf corporations” ready for purchase by a land buyer. What this term means is that the corporation was formed and paid for by the law firm and they have it there for this purpose, ready to be used by such a client.

The concern when purchasing an existing corporation is its history. It is impossible to determine what, if any, obligations may have been made in the name of a corporation. If a buyer were to purchase a corporation from a land owner, they could conceivably have someone show up on their doorstep a few days, months, or years later with a contract signed by the previous “president” of the corporation, in the name of that corporation (now yours), and guess what? If you don’t pay the obligation, this fellow can go after your land, which your corporation owns. This concern is essentially nil when buying a shelf corporation from a reputable law firm.

On the other side of the coin, there are some compelling reasons to purchase the corporation that owns the property. This reduces the closing costs since the sale of a corporation does not involve any transfer of title. The title is owned by the corporation, and continues on as such after the sale. The sale is merely the sale of a corporation with its assets, whatever they may be. The property remains in the possession of the corporation, and the national registry remains unchanged. This is a simple and inexpensive transaction, not unlike buying a pair of shoes, well not quite, but you get the idea. There is, of course, still due diligence required with respect to the basics of a land transaction. A title study, the survey checked for accuracy, disclosure regarding road care, water system, and electrical service, but again, there is no transfer of title.

So it’s good to be informed. I would consider doing such a transaction with a developer that has a number of lots, and he/she has put each of the lots in its own corporation for the purpose of making the purchase of those lots easier and cheaper for the buyer. But in the case of finding a stand alone property where the current owner offers to sell their corporation, I would likely advise against it. The Purchase and Sale contract should include a declaration on the part of the seller that he hereby does swear on all that is good and holy that there is no history to this corporation, and that if there turns out to be… well I think you get the general idea.

In Costa Rica right now, a shelf corporation will run you between $500 and $700 US. This is the most common scenario in my real estate business. I have a long standing relationship with Randall Sanchez in San Isidro de Perez Zeledon. His firm is called “Bufete Sanchez” and I’m not sure why. I keep meaning to ask him why law firms in Costa Rica call themselves “bufetes” (boo-feh-teh) and perhaps one of these days I’ll remember to ask him. Anyway, at any given time Mr. Sanchez has 40 or so shelf corporations ready to go. These corporations are sitting there with no history and ready to use.

So “additional expense” number one of two is the corporation for somewhere between $400 and $600.

The second “additional expense” is that the roughly 4% of sale’s price transaction fee that is normally split 50/50 between buyer and seller. So the buyer would pay a 2%-ish closing fee. This figure includes the transfer of title fee, and various taxes and so on that add up to the 4% amount.

Obviously, if it is legal, and common to under declare the value of a land deal, both the buyer and the seller of a piece of land will benefit from a lower closing cost amount. The vast majority of the sales that I have brokered have been for full amount. But what I gather from the “street” is that a normal "declared value" on a land transaction is $20,000. Compare 4% of that figure to 4% of $250,000 and you’ll see why some sellers of land, who customarily pay ½ of the closing fees, will push a buyer to under declare.

Here is the crux of the biscuit.

There is no capital gains tax in Costa Rica. There should be. There is no logical reason why not. As I have mentioned in a previous “tax” related article, there are a lot of subsistence, coffee, and various crop type farmers in Costa Rica. Farmers own a lot of land. This land is zoned “agrícola” or agricultural, which also happens to be the zoning on nearly all of our single family lots and large parcels. I can’t imagine that the Costa Rican government will ever touch the existing arrangement with regards to such land since it has worked well for years and the declared value on a gazillion farms all over Costa Rica is probably somewhere around $5.00 US (just guessing), making the annual tax bill affordable for such farmers. If this were to change, it could have a seriously negative affect on many hard working farmer families and subsequently on the Costa Rican economy. However, there is no reason for there not to be a capital gains tax. If one of these subsistence farmers were to sell a property at today’s prices, he/she would have the funds from that sale with which to pay the capital gains tax.

Capital gains tax is coming, we just don’t know when. The government body that will likely enact such a tax is a little distracted at the moment with CAFTA (Central America Free Trade Agreement) which is an extremely thorny endeavor considering that the electric, phone, and Telecommunications of Costa Rica is handled by government controlled monopolies which have to change per the terms of CAFTA.

I’m sorry that we’re running a bit long with this one, but in order to tie all this together there remains just a bit more, and this part is key.

The question that a land owner now has is, “why can’t I just under declare on my purchase value, and then re-assess the property when I get close to selling that property?”

The declared purchase price is registered in the National Registry (www.registronacional.go.cr). This doesn’t change when there is a reassessment of the property value. The only thing that changes with the new assessment is the amount of tax that the land owner pays annually. When that property seller goes to sell, his capital gain will be calculated, not on the amount of the new "tax" assessment, but on the price that he/she is registered as having paid for the land.

So, the decision is yours/ours. To under declare or not. My thought is that the best financial decision is to declare full value and thus pay less capital gains tax when there is one in Costa Rica.

Costa Rica Land Tax Change?

I received a question in the forum at Dominical.biz by a gentleman who wondered if he should continue in his endeavor to retire to Costa Rica. His concern was based on a recent article on the front page of the Tico Times that described some rather frightening tax scenarios for owners of Maritime Zone properties up north in the Guanacaste Province. There was the example of a couple whose beachside property’s taxes were increased from $70 annually to $15,000.

I have had a number of clients wonder if maybe the days of Costa Rica being a good investment, and a place to retire are over. It would seem from the various questions that I get that the article gives the idea that there is a new tax law in Costa Rica. So, being the ever vigilant real estate agent that I am, I called my lawyer to ask about the “new tax laws”. The answer surprised me. “Don Benjamin, there is no new tax law”, nor was the existing tax law changed. What the Costa Rican government is doing is re-assessing properties, primarily in the Maritime Zone. The extreme increase in taxes resulted from two likely causes.

1. Enormous appreciation of the property since it was last assessed
2. Likely the "declared value" of the property when it was bought by the current owners was considerably less than what they actually paid for it. This is a common practice here in Costa Rica.

To understand the amount of appreciation that has occurred here in Costa Rica over the last 15 years, we have to understand some about the culture. Land was essentially “value-less”, it didn’t really factor into a family’s budget concerns, not that they really had any budget concerns. The point being, land was a given. Someone in the family had a property large enough, usually much larger than necessary, to house everyone in the family, and their friends too. Well that may be a bit of an exaggeration, but you get the point. The Tico (Costa Rican) culture was, and still is to a lesser degree now, mulit-generational. To this day, a number of my friends in San Isidro de Perez Zeledon, live on a now smaller piece of land with a cluster of Tico style houses where you will find grandparents and great grandparents, as well as adult sisters and brothers with their families living. Family compounds are what I guess we’d call them in our culture.

So up until our start date of say, 1993 for understanding the valuating of Costa Rica land, many Tico families lived on property that was multi manzanas in size. (A manzana, as you may know means “apple” in Spanish. However, in Costa Rica it also means a piece of land that measures 1.7 acres. “Manzana” is not unique to Costa Rica, but it is one of very few countries that uses that measurement.) It seems that a 60 manzana parcel was a common size for a homestead stake. Land was so value-less at that time that the government was looking for men that would simply take responsibility for a particular piece of land, so they granted them ownership rights to the land simply by the Tico land owner being willing to own the property. From that point on, anyone in the family, due to the cultural structure, could live on that piece with their extended family in close proximity.

Then came the foreigners. Upon discovering the beautiful beaches of Costa Rica, as well as its expansive valley and mountain views, and postcard overlooks of quilted patchwork coffee fields, adventurous foreigners would approach one of these land owners about purchasing their property. Money, to the Tico at that time, was hard to come by. When I arrived in Costa Rica in 1999, the going wage for most labor services was around .80 - $1.00 per hour. The Tico didn’t have a mortgage nor rent in mind for what he needed to earn. Housing was essentially free. They would get the wood they needed to build their house from the trees that were in abundance on the family farm. Family and friends would help with the construction. Houses were not built in a permanent way and they would need to rebuild the house after some years. The exceptions to this were when there were certain types of woods available that essentially have the same durability as cement. Manú is one and there is another called Ajo, or “garlic wood”. Houses built with these woods are still around. These little Tico houses that endure to the present have the most beautiful wooden floors in them, burnished by years of foot traffic and daily sweepings and waxings.

The concept of say, $10,000, was nearly inconceivable to the people that lived at that time in that cultural structure. This really wasn’t that long ago. Comparative values in the States and Europe made the land here seem free. Twenty acres of ocean view property for $10,000? Imagine! Add to this the custom of under-declaring the value of the transaction so that the title transfer taxes would be almost nil all add up to the situation that we have now with this re-assessment situation. The properties of Costa Rica are registered as having a value of $3,000 lets say. In more recent times the figure of $20,000 is a common declared value. By the way, this practice of under-declaring is not illegal and is universal in its practice.

There is currently no capital gains tax in Costa Rica. There is no reason for there not to be, so we are expecting a capital gains tax at some point. When this happens, there will no doubt be a period of time during which land owners will be able to reassess their properties. For those that don't reassess, there will be some huge hits, such as those cited in the Tico Times article, to those who are sitting on a property with a declared value of $3,000 and the property then sells for $500,000.

The properties discussed in the Tico Times articles were all in the Maritime Zone (Google: “Maritime Zone” or “Zona Maritima”, “plan regulador”). Most of our land deals here in the Dominical, Uvita, Ojochal area are on land that is titled and is classified “Agrícola” or agricultural. Agricultural zoning serves the needs of single family lots just fine. You can build on 15% of the land size, and the minimum lot size is generally 5,000 square meters (1.25 acres). I can’t imagine that the tax laws for these types of properties will be changing any time soon. Nor do I see a push to re-assess such properties in the foreseeable future. Costa Rica is still made up of the farming, family compound-like life style. To enact such a change in law, or require that the Tico farmer pay annual taxes on the modern value given to his land, would severely hurt a large percentage of Costa Rica’s people. Conversely it makes sense to focus such taxation concerns on the zones where large hotels and lucrative tourism enterprises reside.

Please keep in mind that this viewpoint is derived from my personal observations of this land and the time that I have of living here and being fascinated by the new and different culture among which I live. In other words, I reserve the right to be wrong and to have the Costa Rican government surprise me. But I suspect that you can understand the logic.

If you are looking to invest in Costa Rica real estate, you must learn all you can and develop your own crystal ball. What do you think is going to happen? As a land owner and real estate broker here, I feel sufficiently secure and optimistic about what is going on with regards to ownership rights and taxation to continue building and working my portfolio of properties, and helping others to do the same.