Talking Expat Taxes #4
How to Legally Navigate Costa Rican Property Purchases
Join Alex McGowin as he welcomes back Rick Philps, an expert in Costa Rican property law, to delve into the legal intricacies of purchasing real estate in Costa Rica. This episode covers the key differences between US/Canadian and Costa Rican legal systems, the roles of notaries and realtors, and crucial advice for expats looking to invest. Whether you're dreaming of a tropical rental or a permanent move, this episode provides essential tips to ensure your investment is secure.
Show Notes
“Local knowledge is everything when selecting a realtor in Costa Rica; there’s no formal MLS system, so choose wisely.”
Takeaways
Understanding the System
Costa Rica’s civil law system is fundamentally different from common law in the U.S. and Canada, requiring specific legal expertise.
Due Diligence
Conduct thorough due diligence, as there’s minimal regulatory oversight in Costa Rica’s real estate market.
Professional Help
Hiring a qualified local team—including realtors, lawyers, and notaries—is critical to navigating property purchases successfully.
Ownership Structure
Consider your long-term plans when deciding between personal ownership and corporate entities for property in Costa Rica.
“When buying real estate in Costa Rica, trust but verify—there’s little oversight, so it's crucial to do your own due diligence.”
Today's Guest
Rick Philps
![Rick Philps](https://cdn.sanity.io/images/e33p21b2/production/faff6207fdf91b73c92e14be70a001b2586c295b-1016x1200.jpg?rect=0,1,1016,1199&w=300&h=354&auto=format)
Rick Philps, a dynamic legal professional, bridges the gap between Canada and Costa Rica. Originally from Victoria, British Columbia, Rick holds a BA and a Bachelor of Laws from the University of Victoria. After a successful 14-year law practice in Canada, he embraced a new adventure in Costa Rica in 1998. Rick furthered his legal education there, earning honors in Civil Law and a Post-Graduate Degree in Notary and Registry Law. Since 2003, he's been a trusted expert in Real Estate, Corporate and Commercial Law, Contracts, Wills and Estate Planning, and Immigration. As a member of the Costa Rica College of Lawyers and a qualified Notary Public, Rick brings a wealth of knowledge and a personable approach to every client. Today, he's sharing his experience with our audience.costaricacanadalaw.comEmail Rick
Hey Rick, welcome back to the podcast. Glad to have you on again to talk about some real estate stuff. Last time we dug into your background and we talked a little bit more about the immigration side and the options that people have as far as immigration and in some cases related to real estate transactions. But today, the plan is to talk a little bit more specifically about investing in Costa Rican real estate. A lot of times I have clients that come to me, sometimes they're already in that process and they want to understand the tax situation related to it. But honestly, a lot of times, the typical scenario is somebody vacations in Costa Rica, they love it, want to buy rental property there and move there eventually. So where do they start? What's the first step and then what are some of the things that they need to walk through and be aware of? So that's kind of the goal today and we really appreciate your insight on these things. Welcome back to the podcast. Glad to have you here again.
Hi Alex, it's a pleasure to be here and I'm very pleased to be able to discuss the issues of real estate purchase in Costa Rica.
Understanding Costa Rica's Legal System
I think what your viewers need to know from the outset is that Costa Rica of course uses a different legal system than what is used throughout Canada and the United States. Canada and the United States, it's the English common law system. Costa Rica, it's the civil law system and it does have a significant difference in processes that are used. Things such as the participants within the legal system are with similar names but have different obligations. One good example is that in the civil law system, all notaries must first be lawyers.
The Role of Notaries in Costa Rican Real Estate
You take an additional year of university to obtain a notary degree and then occupy a position in the legal system where they're empowered by the Costa Rica government to transfer property titles by way of public deeds in a public deed book that's provided by the government. So they have a different role entirely than what you would find in the United States or Canada. They also do certifications of documents and authentication of signatures, but the main rules that they play is the actual drafting of these public deeds to accomplish various tasks within the legal system that are normally done by lawyers in both the United States and Canada. So that's just one example of a difference there.
Okay, So the people drafting those things, those are usually government employees that have that designation or level of experience, as opposed to like in the US, it's typically your title company that will have a lawyer that can do those sort of things, or even a notary certainly doesn't require a law degree in the US.
No, no, it's a totally different function and that's why I use that example. The notary is still acting privately in the capacity of a notary but with the authority given by the government to draft public deed and transfer money.
Yeah, Okay. So is that somebody you have to hire? Is that somebody that, if you're purchasing Costa Rican property, it's somebody you'd have to seek out on your own to hire to be a part of this process or that's a part of the government part of the transition?
In scenarios where you're dealing with real estate lawyers, of course there will always be lawyers and notaries practicing together. So they will be all together in one location.
Right, I see. They just operate in a different capacity than in Canada or the US. That makes sense.
Costa Rican Forms Are as Important as the Substance They Contain
So that's an important distinction to know from the beginning because I have a law degree both in English common law from Canada and Costa Rica. Of course I understand these distinctions very well because I've practiced under both systems. Certainly the civil law system in Costa Rica is a much more document formal system. The form of documents is as important as the substance they contain. It might sound like a funny thing to say, but everything's got to have particular stamps on it and things of that nature. If it doesn't have those types of formalities, it can fail in the purpose that it's been created for. So it's a more finicky system to deal in than English common law, but nevertheless, that's what Costa Rica uses.
Right. It still honestly sounds very American. The more you're describing it. It sounds like my last DMV visit where I didn't sign Alexander, which is my real name. I signed Alex and that little intricacy, I had to start over on the whole process. So yeah, I understand what you're saying. It's a different thing, but still equally as detail oriented.
Yes, and as I say, even more so than the English common law system. More demanding in formal area. Those are issues, of course, more for the notaries and lawyers that are practicing. Obviously, it's to the advantage of clients to understand that that is the kind of system they're dealing in and to seek out the appropriate professionals, of course.
Yeah, so it goes to make sure you hire the right professional and one that has obviously experience with the civil law system in Costa Rica or even somewhere else.
Yeah, exactly. Yes, well of course in order to practice law in Costa Rica you have to have a civil law degree from a Costa Rica institution and be a member of the College of Lawyers in Costa Rica, which is like being a member of the Bar Association. So those are requirements. It's an oversight body, the College of Lawyers is an oversight body, much like a bar association would be in the US or Canada.
Finding Real Estate Professionals In Costa Rica
Right, makes sense. Let's say if you're starting this process, you're an American or Canadian looking to invest in Costa Rica, what's the team you should assemble? You know what I mean? Obviously the attorney's part of it, but what does that team look like for people that you need to put together specifically in Costa Rica?
Yes, initially of course you'll be dealing with a realtor. Obviously they have access to the inventory of properties in a particular area that you would be interested in purchasing in Costa Rica. The important thing to know about realtors in Costa Rica is that there are no laws or regulations in effect governing the real estate industry in Costa Rica at all. And there is no professionally sanctioned oversight body that has any control over realtors from a disciplinary point of view or any other regulatory matter. Realtors can operate with no training, no license. And if they are bad actors, they can continue to do that activity regardless because there's no professional body or legal system that will prevent them from doing it. It's a strange thing.
Right. That's a major difference from the US for sure.
It's a major difference from the US and Canada and I think it's something people have to know from the outset that it's extremely important to do the due diligence necessary, check references, make other inquiries about the realtor you're going to be dealing with. There's many realtors in Costa Rica that have been realtors in other jurisdictions like the US and Canada. Legal systems are different, but at least with professional training as a realtor in another jurisdiction, you're likely to be a more adept person to assist the purchaser in Costa Rica. Learning the differences in the legal system, of course, is something a realtor has to acquire on their own. There's no formal training. There are two voluntary membership associations that realtors can belong to, which are what I would call ethics oversight associations, but they are voluntary membership only and the worst thing that can happen to you is that your membership can be cancelled for any bad behavior that you might be guilty of by those associations.
Right, but you can keep on doing your job like you've been doing. There's no license.
Yeah, there's no absolute oversight that filters out bad realtors. So really it falls to the purchaser to make these inquiries. The other thing that's very important to note is there's no formal MLS system operating in Costa Rica that is comprehensive throughout the country. So the other circumstance of choosing a realtor is that you have to choose a realtor who's knowledgeable in the area of Costa Rica where you want to purchase. Local knowledge is everything because there is no MLS system that you can go to to look up all of the properties that are available.
Why Local Knowledge is Crucial
Right. Meaning be a little careful hiring a realtor based in San Jose if you're looking for a property in Jaco or somewhere outside of San Jose. Try to find somebody in that area.
Absolutely. No, it's crucial that you find a realtor with very, very good local knowledge in the area that you want to purchase. That's a critical point.
Yeah, I know you're not a realtor, but I'm curious if you know this. How are realtors generally paid in Costa Rica? Is it similar to the US and maybe Canada as far as the buyer and the seller both share in commissions or do you know how that generally works?
Yeah, usually there is a listing realtor. They can also be the realtor for a purchaser if the purchaser happens to speak with them first about a particular property. If a separate realtor brings a client to the listing realtor, of course they share a commission. The usual commission for a ready-built property is 6 % and for vacant land 10%. There's usually a 50 -50 split between listing and purchaser realtors if that's the case or the listing realtor would be entitled to the full commission if they also produced the purchaser.
Gotcha. Okay. All right. Makes sense. So make sure you have a qualified realtor in your general area that you're looking for.
Yes, the other thing too is, of course, if your realtor is Costa Rican, there's no issue about working, but if your realtor is a foreigner, then you have to establish the appropriate immigration status to in fact sell real estate in Costa Rica. In other words, permanent residency status is the status you need to acquire, which does take three years following temporary residency before you can acquire that status. So it's important to know that your realtor is practicing under the correct immigration status as well if they're a foreigner.
Right. Understood. Okay, makes sense. So, let's dive into some of the legal side now, which is more your specific part. What are the steps from a legal perspective that people need to go through and be aware of?
When a purchaser has found a property they're interested in, of course. Initially the realtor would do a letter of intent or some very basic offer. The offer was accepted then that's where the real estate lawyer becomes involved to actually draft an interim purchase and sale agreement that would set out all the particulars of the property in the parties, the agreed upon price, potential closing date for the transaction and a due diligence period where all of the subject twos would have to be satisfied as to what the purchaser wants to investigate before they make the deposit firm. At the time of the interim purchase agreement being signed, there will also be normally a 10% deposit placed in escrow by the purchaser. Escrow is used extensively. No direct deposits to a seller or to realtor. They go to an actual escrow company where they're held.
We usually call that earnest money in the US. That deposit is the earnest money where you put a deposit down during that closing period and if you back out at that point after the contract is signed, the seller keeps the money. Or if it breaks the stipulation of the contract, then you get your earnest money back. That's that deposit basically.
The normal process is that during the due diligence period, which can vary, but is normally in the three week to one month time frame when a purchaser would be making inquiries. Say if it's a built property, you'd be getting in a home inspector to make an inquiry about that, possibly a land surveyor if there isn't a current survey of the property to check the boundaries to make sure there's no encroachments, things of that nature. The real estate lawyer, of course, would be doing a property title search in the National Registry to see if there were any unusual annotations on the title during that period. During this investigation period, the due diligence period, as it's referred to, the deposit is refundable until the purchaser says they're satisfied with the due diligence at the end of that period. So at the end of the three weeks or a month, whatever the due diligence period is, the purchaser has to say yes, they want to continue, or no, they don't. If they don't, then they get their money back. If they do continue, the deposit becomes firm, but it is payable at closing. It is not paid at that moment. It's held in escrow, and the balance of the purchase monies, of course, are deposited into the escrow account to complete the closing.
Structuring Ownership: Personal vs Corporate
Right. Yeah, that makes sense. So, that's the due diligence period. And one thing - I don't know if I'm jumping ahead - but one of the main questions I get from clients, definitely from a US perspective, is how to structure these purchases. In the US, a typical scenario for a rental property is to set up a US LLC which generally acts as a flow through entity for US tax purposes and the LLC is going to hold that rental property. What do you typically suggest with clients or what are their options as far as who holds the title to that property in Costa Rica?
Well, as far as purchasing a property in Costa Rica, if it's going to be an investment property where the purchasers are not going to be living in it as a primary residence, it's more convenient to have it in a corporation. If it's a husband and wife or a single person purchasing an SRL company, it's the more convenient one to use because it only requires one manager to actually manage, not a full board of directors. And there will not be any significant share transfers between a single person or a married couple other than at the time of selling the property in the future.
Whereas, Associated Anonymous Company, an SA, requires a full board of directors, although the share transfers can be done by endorsement, so it's more conducive to a group of investors, or say eight or ten investors want to get together and buy investment property. During the course of owning that investment property, some investors may want to sell their share or interest. An SA would be more conducive to allowing an endorsement of the shares to a purchaser of that interest. In the SRL, if the same scenario existed, you would have to have the consent of 75% of the other shareholders in that SRL in order to do any interim share transfer of a single shareholder.
Right. Okay, if you're looking at more like a family type rental property that you're going to own, maybe pass to your kids one day, but generally it's going to be husband and wife or a single person. The SRL makes the most sense. It's not really worth it to go the more complicated route of the SA, but if this is an investment property, you have potential sales and different transactions going on at the top level, the SA may make more sense locally.
Yes, yes that's correct. Other consideration is if the property is going to be a principal residence and you're thinking about it in terms of a residency application in Costa Rica, it's important that the property be registered in the personal names of the owners in order to apply for residency. You cannot use the shares of a registered corporate owner of property unless that company is an active tax paying entity in Costa Rica. So it's an important decision as to how you will be using the property that you're purchasing in Costa Rica. Principal residence, better in your personal names, investment property, better in the corporation.
Okay. What is the general benefit of having it in a company versus having it owned personally? Is it liability protection at the end of the day? So with a rental property, is there the benefit of the local liability protection?
Yes, you do have the limited liability protection of having it in a company. Costa Rica is not a litigious jurisdiction by any stretch of the imagination like the US or Canada. Normal homeowner policies with a liability clause. They're not expensive and they give you really all the protection you would enjoy if it was in a corporation. So owning the property in your personal name really is not an issue when it comes to issues of liability. Insurance premiums are not expensive and they equate with the same liability protection that you would enjoy.
Other than that, if it's going to be your principal residence, another reason why you'd want to put it in your personal name is that there's a lot of annual filings associated with companies. On average, a normal registered owner company of a property would incur about $700 a year in annual government filings and additional taxes. Flat taxes that are assessed against companies that aren't assessed against personal owners. So that's another consideration.
And that would not be the case if it was owned by a company? Is that what you mean? Are you comparing the fees associated with personal ownership to the fees associated with company ownership?
Yeah, the personal ownership doesn't carry the same fees as corporate ownership annually with the government. There's a shareholders registry filing that's required. There's an inactive company tax department filing even if the company's not doing any business. Things of this nature where you have to have them prepared by professionals and filed. There's also a flat corporation tax that has to be paid for an act of companies that's about $120 a year at the moment. If the company is registered in a corporation, that wouldn't be incurred if it was in a personal name. So if it's going to be a principal residence, really there's no real advantage of having it in a corporation, only if it's an investment.
Understood. That's a big question I get. And from a US tax perspective, certainly if it's a personal residence and there's going to be no income on it, owning it in a foreign corporation potentially just adds a filing requirement on the individual's US tax return because the ownership of a foreign corporation triggers a controlled foreign corporation filing. It's arguable if there's no income and it's not doing any business that you actually have to file that form or not. I haven't found anything clear one way or the other on that. I generally still file it. But definitely for a rental property, one thing I just wanted to point out is in the US, if you're a US citizen and you set up a company in Costa Rica, that provides limited liability protection. Both the SA and the SRL provide limited liability protection to them. The default is that it's a foreign corporation for US tax purposes. If that's a rental property, you now have this foreign corporation. But if you set up an SA or with the SRL, you can actually elect to treat that as a flow through from a US perspective, which is generally what I do with my clients if they have a rental property in Costa Rica, they set up an SRL. If I know about it on the front end, I'll make that election so that it treats it as a flow through and we don't have to deal with foreign corporation nuances. But with the SA, it's what's called a per se foreign corporation for US tax purposes. So you cannot elect to treat it as a flow through. I guess there's definitely reasons to do that because it'd be easier to transfer ownership like you mentioned. But you're kind of locked out of that flow through treatment in the US if you go the SA route, which isn't the worst thing in the world. There's things that we can do to plan around that, but it's just something to take into account. Like with everything, there's not one clear answer that fits all objectives. We need to look at all the objectives and weigh them to see. Does the best tax answer necessarily give you the best estate planning answer and vice versa? So just something I wanted to point out the differences from a US tax perspective.
In any circumstance, like purchasing property in Costa Rica, really you need an accountant available in both the United States or Canada and in Costa Rica. Especially if it's an investment property, to sort out all of the requirements in both jurisdictions.
Your point's really interesting on the individual ownership because honestly that simplifies things from a US perspective because then you don't have a foreign company at all. Arguably, you have a foreign trade or business if it's a rental property regardless of whether there's an entity or not. In my experience, most people set up the the SRL almost as a knee -jerk reaction, which is what they do in the US with LLCs, although the US is obviously much more litigious than probably any country, definitely Costa Rica. It's an interesting point, if there's a principal residence, there may not be, at least a liability protection reason, to set up the SRL. It just kind of complicates things and adds fees for no particular benefit.
Yes, certainly my advice to clients is basically if they're going be living in the property they're purchasing, they register it in their personal names. If it's going to be an investment property only, where they're remaining primarily in their home country, it's better to manage it through a corporation in Costa Rica.
Navigating the Real Estate Purchase Process
Gotcha. Good points. So now we've got our company set up and we have our legal team and we have our realtors... What are some other things that we need to look out for when going through this purchasing process?
Setting up of the escrow account is very important. Costa Rica was given an ultimatum by banking institutions about 15 years ago that they had to be much more diligent about money laundering activity that was taking place. And by my best knowledge, probably still is. In Costa Rica, but have much more oversight over foreign money entering the country. So about 15 years ago, there were three escrow companies that really took over the entire escrow market in Costa Rica and all real estate lawyers recommend one of these three companies to their purchasing clients to use in the escrow process. It's quite an in depth process to actually open the escrow account by the purchaser. They will definitely be looking at the source of funds that will be coming to Costa Rica and they will want not only banking documentation from the bank account that it's coming from, but how the money got into that bank account? Did it come from an inheritance? Did it come from a property sale? Did it come from investment income? Did it come from regular income? All of that is going to have to be documented to the escrow company to the extent that it covers the amount of money to be transferred to complete the purchase. So there's going to be some, shall we say, uncomfortable personal financial inquiry made at that time that purchasers need to be aware of and unless these sources of income are provided in a satisfactory manner to the escrow company, the escrow company is under very strict regulations by the banking regulatory authorities in Costa Rica not to set up the escrow account if the source cannot be determined with complete accuracy. It is something that a lot of people will come back to me and say, well, they're asking me for this and that, do I really have to give them that? Well, unfortunately, yes, you probably do.
Right. It's kind of a more is better, sort of thing.
Yes. And it's because, as I say, Costa Rica was really delivered an ultimatum by the international banking community about 15 years ago saying either you clean up your act with respect to preventing money laundering or you're going to be denied access to international banking systems to do business.
Interesting. So what kind of information, if you're self-employed in the US, people are providing maybe US tax returns, financial statements, bank statements, all that. Basically everything you can think of with numbers on it related to your business, send it over.
Yes. Correct. Exactly. And yeah, monthly bank statements for the six current months going back. Definitely the most recent tax return. Those documents for sure. The escrow company, of course, looks at every circumstance on an individual basis as to what other documents might be required. They'll certainly get what has to be provided.
Very interesting. Like any real estate purchase, real estate purchases have a lot of steps associated with them and they can be complicated, as you know, really no different than anywhere else, make sure you have the right team and talk to the right people, get advice from the right people to help you through the process. I'd just be curious about one last thing before we jump off. I'd like to hear, is there any one or two specific problems or issues that you see or maybe things that surprise an American or Canadian going into this process that they seem surprised by? Just curious, what are some things that may surprise you if you embark on this journey of Costa Rican home ownership?
Common Pitfalls and How to Avoid Them
The thing that I think purchasers need to be aware of more than anything else is the lack of oversight either by government or professional oversight bodies at every step of a property purchase, whether it be realtors, even the law society that lacks an oversight of lawyers even though the rules and regulations are there. It's a country where you have to be more on top of things from a personal perspective, looking at purchasing the property from the view of doing all of the due diligence steps and overseeing them yourself to make sure they're done correctly, hiring the correct people to do those steps like a home inspector who's qualified to do home inspections, not just a friend of the realtor that'll do something slapdash and make sure the commission is earned. Unfortunately, those kinds of things do happen. It's just that there's no oversight protection in the system to sort that out and hold those kinds of people accountable for what I would deem unprofessional behavior. So you just have to be aware of that and be on top of things and understand that you're going to have to really look for references, really make inquiries on your own behalf to know that you're getting the proper professionals acting for you in the transaction that will have your interests only at heart and not be compromised in any way with other parties that are involved in the transaction.
Conclusion
Trust but verify as they say. Thanks a lot Rick. This has been really great information. I think this will really help people to understand some of the things they need to look out for when they go on this real estate purchasing journey in Costa Rica, which is not a bad place to be spending some time. So, thanks again for coming on. Appreciate all your insights and hopefully we talk again soon.
Okay, thanks very much, my pleasure Alex. See you soon.
All right, see you, Rick.