Mexico Property Depreciation: The US Tax Benefit Most Cabo Owners Miss

The Deduction Hiding in Plain Sight

I am not a CPA, and nothing in this post is tax advice — you need a cross-border tax professional for your specific situation. But I have watched enough Cabo property owners leave money on the table that I feel obligated to write this. If you are a US citizen or green card holder who rents out your Los Cabos property for any part of the year, you can depreciate that property on your US federal tax return. The IRS allows it. The math is significant. And most owners either do not claim it or claim it incorrectly.

The depreciation deduction reduces your taxable rental income — meaning you pay less US federal income tax on the money your Cabo property generates. Over the life of the property, this deduction can total hundreds of thousands of dollars.

Key Takeaways

• Depreciation period: Foreign residential rental property must use the Alternative Depreciation System (ADS) — 30 years straight-line, not the 27.5-year MACRS used for US rental property
• Annual deduction example: A $600K Cabo condo (excluding land value) generates a $20,000 annual depreciation deduction, reducing taxable rental income by that amount for 30 years
• Reporting: Foreign rental income goes on Schedule E; the property itself requires Form 8858 (Information Return of US Persons With Respect to Foreign Disregarded Entities)
• Land exclusion: You can only depreciate the building/improvement value, not the land — work with your CPA to establish the correct allocation (typically 20–40% land in Los Cabos depending on location)
• Foreign tax credit: Mexico's ISR (income tax) paid on rental income can offset your US tax liability via Form 1116, preventing double taxation under the US-Mexico tax treaty

How Foreign Property Depreciation Works

US tax law requires all taxpayers to report worldwide income, including rental income from foreign property. The flipside is that you also get worldwide deductions — including depreciation on the foreign property generating that income.

The ADS Requirement

Domestic US rental property is depreciated over 27.5 years using the Modified Accelerated Cost Recovery System (MACRS). Foreign rental property cannot use MACRS — the IRS requires the Alternative Depreciation System (ADS), which extends the depreciation period to 30 years for residential property and 40 years for commercial property.

The 30-year ADS period uses straight-line depreciation, meaning you deduct the same amount every year. There is no accelerated component, no bonus depreciation, and no Section 179 for foreign property. It is simple, predictable math.

Running the Numbers

Here is the depreciation calculation for a typical Cabo investment:

Item	Amount
Purchase price	$800,000
Land allocation (30%)	−$240,000
Depreciable basis (building only)	$560,000
ADS depreciation period	30 years
Annual depreciation deduction	$18,667/year

If your Cabo property generates $60,000 in gross rental income and you have $25,000 in operating expenses (management, maintenance, insurance, HOA), your net rental income before depreciation is $35,000. After the $18,667 depreciation deduction, your taxable rental income drops to $16,333. At a 32% federal tax bracket, that depreciation saves you $5,973 in federal income tax every year — for 30 years.

The Land Allocation Challenge

The IRS only allows depreciation on the building/improvement portion of your property, not the land. For US domestic property, the county assessor's tax records typically break out land and improvement values. Mexico does not have an equivalent public breakdown.

Your CPA will need to establish a reasonable land-to-improvement allocation. Common methods include:

• Catastro breakdown: The Mexican catastro (property tax assessment) sometimes includes separate land and construction values. If available, this is the simplest defensible allocation.
• Appraisal method: A formal appraisal (avalúo) that breaks out land and construction values. This costs $500–$1,500 but creates a defensible IRS record.
• Comparable allocation: Using the ratio of land-to-improvement values from comparable US properties in similar resort markets. Less defensible but commonly used.

In Los Cabos, land typically represents 20–40% of total property value, depending on location. A beachfront lot in Palmilla might be 40% land value. A condo in a mid-rise building in San Jose del Cabo might be 15–20% land value. The higher the improvement percentage, the larger your annual depreciation deduction.

Three Mistakes I See Constantly

Mistake 1: Using 27.5 Years Instead of 30

The most common error. A CPA who does not specialize in foreign property will default to the familiar 27.5-year MACRS period used for domestic rentals. The IRS specifically requires ADS (30 years) for property "used predominantly outside the United States." If you are audited and the IRS finds a 27.5-year depreciation schedule on a Mexican property, they will recalculate and assess back taxes plus interest.

Mistake 2: Not Claiming Depreciation at All

Some owners — and some CPAs — incorrectly believe that foreign property cannot be depreciated on a US return. This is wrong. IRC Section 168(g)(1)(A) explicitly requires ADS for foreign property, and the depreciation deduction is mandatory — the IRS actually requires you to reduce your basis by the "allowable" depreciation whether or not you claim it. If you do not claim it, you lose the annual tax benefit but still have to pay depreciation recapture when you sell.

Mistake 3: Not Filing Form 8858

If you own your Cabo property through a fideicomiso (bank trust) — which most foreign owners in the restricted zone do — the IRS considers the trust a "foreign disregarded entity." This triggers a Form 8858 filing requirement alongside your Schedule E. The penalty for not filing Form 8858 is $10,000 per year per entity. Many CPAs miss this because they do not encounter foreign trusts regularly.

Depreciation Recapture: The Exit Cost

Depreciation is not free money — it is a deferral. When you sell the property, the IRS recaptures the depreciation you claimed (or should have claimed) at a maximum rate of 25% under Section 1250. If you depreciated $18,667/year for 10 years ($186,670 total), you owe up to $46,668 in depreciation recapture tax at sale.

This recapture is due regardless of whether you actually claimed the depreciation — the IRS taxes you on the "allowable" amount even if you did not take it. This is why claiming the deduction every year is critical: you pay the recapture either way, so you might as well take the annual benefit.

The Foreign Tax Credit Offset

Mexico imposes its own income tax (ISR) on rental income earned within Mexico. As a US taxpayer, you can claim a foreign tax credit via Form 1116 to offset the Mexican tax against your US tax liability. This prevents double taxation on the same income.

The interplay between Mexican ISR, US depreciation deductions, and foreign tax credits is complex enough that a general CPA will likely get it wrong. You need a professional who works both sides of the border — and who understands that the fideicomiso is a disregarded entity for US tax purposes but has specific reporting obligations.

For a deeper look at US tax reporting obligations for Mexico rental income, see the comprehensive guide on US tax reporting for Mexico rental income.