Talking Expat Taxes #4

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.

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.

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.

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.

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.

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.

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, 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.

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.

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.

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.

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, 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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

Okay, thanks very much, my pleasure Alex. See you soon.