US Tax Reporting for Mexico Rental Income: Schedule E, Depreciation, and Foreign Tax Credits

The IRS Taxes Worldwide Income — Including Your Cabo Rental

If you are a US citizen or resident alien, the IRS requires you to report all income earned anywhere in the world, including rental income from your Mexico property. This is true whether you bring the money back to the United States or leave it in your Mexican bank account. It is true whether you report it in Mexico or not. And it is true whether your rental income is $5,000 or $500,000.

The good news: you will not be double-taxed, because the US-Mexico tax treaty and the IRS foreign tax credit system exist specifically to prevent that. But you do need to report correctly on both sides, and the mechanics are not intuitive.

Key Takeaways

• US citizens and residents must report Mexico rental income on IRS Schedule E, regardless of whether the income stays in Mexico. The IRS taxes worldwide income.
• You can depreciate your Mexico property over 27.5 years on your US return, reducing taxable rental income by the annual depreciation amount — even though Mexico uses a 5% (20-year) rate.
• Mexico's ISR (income tax) paid on rental income generates a foreign tax credit on IRS Form 1116, dollar-for-dollar against your US tax liability on the same income. This prevents double taxation.
• The 14-day personal use rule applies: if you use the property more than 14 days (or 10% of rental days, whichever is greater), the IRS treats it as a personal residence and limits your deductible expenses.
• You must file FBAR (FinCEN 114) if the aggregate balance of all your Mexican bank accounts exceeds $10,000 at any point during the year, and Form 8938 (FATCA) if your foreign financial assets exceed $50,000 on the last day of the year or $75,000 at any point.

Schedule E: Reporting Foreign Rental Income

IRS Schedule E (Supplemental Income and Loss) is the form where rental property income and expenses live on your US tax return. Your Mexico rental property goes on Schedule E just like a rental property in Phoenix or Miami — same form, same line items, same logic. The only difference is that some of the numbers start in pesos and need to be converted to dollars.

Currency Conversion Rules

The IRS requires you to convert peso-denominated income and expenses to US dollars. You have two options:

• Actual exchange rate on the date of each transaction — more accurate but labor-intensive.
• Average annual exchange rate published by the IRS — simpler and acceptable for most taxpayers. The IRS publishes yearly average rates on its website. For 2025, the average was approximately 20.3 MXN per USD.

Pick one method and use it consistently. Your CPA will have a preference — usually the annual average unless you have large, concentrated transactions where the rate matters.

Deductible Expenses on Schedule E

You can deduct the same categories of expenses against Mexico rental income that you would for a US rental:

• Property management fees (typically 20–35% of gross rental income in Los Cabos)
• Maintenance and repairs — pool service, A/C maintenance, pest control
• HOA fees ($300–$800/month for Cabo condos, $1,000–$3,000+ for luxury communities)
• Insurance — your Mexican property policy
• Utilities paid by you (CFE electricity, water, internet)
• Travel expenses to the property for management purposes (not vacation trips)
• Legal and professional fees — your Mexican accountant, your US CPA's Mexico-specific work
• Depreciation (see below — this is the big one)

Depreciation: The Most Powerful Deduction You Are Probably Missing

Here is where most Cabo property owners leave money on the table. The IRS allows you to depreciate residential rental property over 27.5 years — the same schedule as a US property. This means you can deduct approximately 3.6% of the building's value (not land) every year against your rental income, even though the property may be appreciating in market value.

Determining the Cost Basis and Land Allocation

You cannot depreciate land — only the structure. For US properties, the IRS and local tax assessors provide clear land-vs-improvement breakdowns. For Mexico properties, you need to establish this allocation yourself:

• Use the avalúo (Mexican appraisal) from your purchase, which typically breaks out land and construction values.
• If the avalúo does not break it out, a reasonable allocation for a Cabo condo is 20–30% land, 70–80% structure. For a beachfront villa, land might be 40–60%.
• Document your allocation method — the IRS can challenge an unreasonable split.

Worked Example

You bought a condo in San Jose del Cabo for $400,000 USD. The avalúo allocates 25% to land and 75% to improvements.

• Depreciable basis: $400,000 × 75% = $300,000
• Annual depreciation: $300,000 ÷ 27.5 = $10,909 per year

That $10,909 is a non-cash deduction that directly reduces your taxable rental income. If your gross rental income is $48,000 and your cash expenses are $20,000, your net income before depreciation is $28,000. After depreciation, it drops to $17,091 — a 39% reduction in taxable income from depreciation alone.

Mexico Uses a Different Rate — That Is Fine

Mexico allows 5% annual depreciation on residential structures (a 20-year schedule) under its tax code. The US uses 3.636% over 27.5 years. These are independent calculations for independent tax systems — you use each country's rate on that country's return. The fact that Mexico gives you a faster depreciation rate does not affect your US calculation, and vice versa.

The Foreign Tax Credit: Avoiding Double Taxation

When you pay Mexico's ISR (Impuesto Sobre la Renta) on your rental income, you can claim that tax payment as a foreign tax credit on your US return using IRS Form 1116. This is a dollar-for-dollar credit against your US tax liability — not a deduction, which is far less valuable.

How Form 1116 Works

Form 1116 calculates the maximum credit you can take. The formula is:

Foreign Tax Credit Limit = US Tax × (Foreign Source Income ÷ Worldwide Income)

If your Mexico ISR is less than this limit, you credit the full ISR amount. If it exceeds the limit (rare for rental income), you carry the excess forward up to 10 years.

Mexico ISR Rates on Rental Income

Mexico taxes non-resident rental income at either:

• 25% flat rate on gross rental income (no deductions) — the simple option that most property managers withhold automatically.
• Progressive rates (up to 35%) on net income after deductions — requires filing a Mexican tax return with deductible expenses. Often results in a lower effective rate.

Most Cabo property owners with management companies use the 25% flat withholding because it is simpler — the management company withholds and remits the ISR, and you receive a constancia (withholding certificate) showing the tax paid. This constancia is your documentation for the Form 1116 foreign tax credit.

The 14-Day Personal Use Rule

This is the IRS rule that trips up vacation-home owners who also rent. If you use your Cabo property for personal purposes for more than the greater of:

• 14 days, or
• 10% of the number of days it is rented at fair market value

...then the IRS classifies it as a personal residence, not a rental property. The consequences:

• You can still deduct rental expenses — but only up to the amount of rental income (no net losses).
• You cannot use excess deductions to offset other income.
• You lose the ability to generate passive losses that offset other income under Section 469.

What Counts as Personal Use?

• Any day you or your family members use the property.
• Any day you let friends or family use it rent-free or below fair market value.
• Days spent at the property performing maintenance or repairs do not count as personal use, as long as the primary purpose is maintenance, not vacation.

For a Cabo property rented 200 nights per year, you can use it personally for up to 20 days (10% of 200) without triggering the personal-use limitation. If you rent it 120 nights, your limit is 14 days (the greater of 14 or 12).

Passive Activity Loss Rules (Section 469)

Rental income is generally classified as "passive" by the IRS, meaning net losses can only offset other passive income — not your W-2 wages or business income. However, there are two important exceptions:

• $25,000 allowance: If your adjusted gross income is below $100,000, you can deduct up to $25,000 in passive rental losses against non-passive income. This phases out between $100K and $150K AGI. Most Cabo buyers are above the phase-out.
• Real estate professional status: If you spend more than 750 hours per year in real estate activities and more than half your working time is in real estate, your rental losses become fully deductible against all income. This is the strategy that real estate professionals (brokers, agents, developers) use to unlock unlimited rental loss deductions. High-income buyers sometimes pursue this status specifically for the tax benefit.

FBAR and FATCA: The Bank Account Reporting Layer

If your Mexico rental income flows through a Mexican bank account — and it probably does — you have additional reporting obligations:

FBAR (FinCEN Report 114)

• File if the aggregate balance of all foreign financial accounts exceeds $10,000 at any point during the year.
• Due April 15 with an automatic extension to October 15.
• Filed electronically with FinCEN (not the IRS), though it is referenced on your tax return.
• Penalties for willful non-filing: up to $100,000 or 50% of the account balance per violation. Non-willful penalties: up to $10,000 per account per year.

Form 8938 (FATCA)

• File if the total value of specified foreign financial assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the year (thresholds are higher for married filing jointly and for taxpayers living abroad).
• Filed with your tax return — this is an IRS form, unlike FBAR.
• Covers financial accounts, foreign securities, and interests in foreign entities — but not the real property itself.

Both FBAR and FATCA apply to the accounts, not the property. Your Cabo condo itself is not reportable on these forms. But the Mexican bank account where your rental deposits land absolutely is.

The Five Mistakes I See Most Often

1. Not depreciating the property at all. Some CPAs unfamiliar with foreign rental properties skip depreciation because they are unsure of the rules. The rules are the same as for domestic property — 27.5 years, land excluded.
2. Deducting ISR instead of crediting it. You have a choice: deduct foreign taxes as an expense or credit them against your US tax. The credit is almost always more valuable. A $7,200 credit reduces your tax bill by $7,200. A $7,200 deduction reduces your taxable income by $7,200, saving you $7,200 × your marginal rate (maybe $2,500).
3. Ignoring the personal-use limitation. Spending three weeks at your Cabo property in December, two weeks in March, and a week in June adds up to 42 days of personal use. If you rented it 200 nights, your 10% threshold is 20 days. You blew past it, and your loss deductions are now limited.
4. Missing the FBAR deadline. FBAR is a separate filing from your tax return. Many taxpayers file their 1040 and forget the FinCEN report. The penalties are disproportionately severe.
5. Using the wrong exchange rate. Your Mexican accountant reports income in pesos. Your US CPA needs dollars. Using a random Google exchange rate instead of the IRS-published rate creates discrepancies that can trigger questions.

Finding a CPA Who Gets Both Sides

Not every CPA handles foreign rental property. You need someone who understands:

• Form 1116 foreign tax credit calculations.
• Mexico's ISR withholding system and constancias.
• Depreciation cost-basis determination for foreign property (avalúo interpretation).
• FBAR and FATCA filing requirements.
• The interaction between Mexico's rental income tax regime and the US-Mexico tax treaty.

I work with buyers who have CPAs in every major US metro. The ones who do this well typically charge $500–$1,500 more than a standard return for the foreign property component. Worth every dollar versus the penalty risk of getting it wrong.