Act 22 Puerto Rico Guide For Individuals | Relocate to Puerto Rico

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A Guide to Act 22 Puerto Rico For Individuals

 

On January 17, 2012, Puerto Rico enacted Act 22, known as the “Individual Investors Act”. This Act was designed to help accelerate the economic recovery of Puerto Rico by attracting high net worth individuals, empty nesters, retirees, and investors to relocate to Puerto Rico.

In short, Act 22 provides 0% capital gains tax for gains you realize after moving to Puerto Rico, assuming you also satisfy calendar year bona-fide residency requirements (as determined by the IRS). This is all possible because the Federal Government does not tax Puerto Rico residents, instead leaving that responsibility to the Puerto Rican government.

There is a separate Act for businesses called Act 20 (see our guide).

What are the tax benefits for Act 22 Puerto Rico?

Eligible new Puerto Rico residents receive the following benefits for income accrued after the individual begins to become a bona-fide resident of Puerto Rico:

  1. 100% tax exemption from Puerto Rico income taxes on all dividends
  2. 100% tax exemption from Puerto Rico income taxes on all interest
  3. 100% tax exemption from Puerto Rico income taxes on all short-term and long-term capital gains

A few points of clarification:

  1. Understanding the ins and outs of bona-fide residency and the key dates associated with it are critical to your relocation and tax strategy. In the example of a stock, which is taxed as personal property and thus a capital gain, the date that establishes your tax basis is the date in which you commence becoming a bona-fide resident; this is also known as your move date, or the date in which you cease to have a tax home in the US. For Act 22 to kick in, you must successfully obtain your tax decree and satisfy bona-fide residency requirements for that calendar year (i.e. actually become a bona-fide resident). If you do not accomplish these steps in full, all income will be taxed in the US (more on this in the next section).
  2. Dividends and interest (benefits 1 and 2 above) are not considered capital gains, but rather “investment income”, because the return is not reliant on the initial capital expenditure. For investment income, the IRS considers the source of income to be where the payer, or company, is located. Therefore, unless the payer is based in Puerto Rico, you will owe US taxes on investment income even after moving to Puerto Rico. See our sources of income table at the bottom of this article for more information.

You need to actually move to Puerto Rico

For Act 22 you need to become a bona-fide resident of Puerto Rico. A bona-fide resident of Puerto Rico is a person who can meet all three of the following IRS tests:

  1. Presence test: individual is present for at least 183 days during the taxable year in Puerto Rico (there are other ways to ways to satisfy). This is known as the “where are you” test.
  2. Tax home test: individual does not have a tax home outside of Puerto Rico during the taxable year. This is known as “the office test”.
  3. Closer connection test: individual does not have a closer connection to the United States or a foreign country than to Puerto Rico. This is known as the “in your heart test”.

We’ve devoted a separate article to explaining these tests in extreme detail – consider it required reading.

When should you actually move to Puerto Rico?

There has long been confusion around which date you should use to establish your tax basis on a security when coming to Puerto Rico, which in turn determines your income tax obligation. Is it January 1 of the year you move? Or your move date? Or your Act 22 application or acceptance date? For capital gains and Act 22, the answer is based on the type of income and your residency status, which is mostly determined by the IRS and not Act 22. The Act 22 component is what then exempts you from Puerto Rico income tax (e.g. Puerto Rico capital gains).

Here’s an example of a stock, which is taxed as personal property based on the owner’s tax home:

  1. Apply for Act 22 anytime during calendar year.
  2. Move to Puerto Rico and take steps to establish residency.
  3. Meet Puerto Rico bona-fide residency requirements during calendar year, which means you are bona-fide resident for that entire year. In general, this means you would need to move before July 1 to achieve 183+ days.
  4. Be able to prove residency when you accept your Act 22 decree, thus making it effective.

For personal property like a stock, your “move date to Puerto Rico” determines the date of sourcing because your tax liability is based on the residence of the taxpayer.

Now that you have your tax basis date established, you need to determine how to allocate the unrealized gain to each jurisdiction. We say unrealized because if you’ve already realized or closed the position prior to moving, this gain is is not relevant for Puerto Rico.

What about your gains before moving to Puerto Rico?

Capital gains accrued before the individual established residency in Puerto Rico (“Non-PR Built-in Gains”) are subject to preferential Puerto Rican income tax rates:

  • Within 10 years – if gain is recognized within 10 years of establishing in Puerto Rico, it will be taxed only at the US federal income tax rate for capital gains.
  • After 10 years – if gain is recognized after 10 years of establishing residency in Puerto Rico, it will be taxed at a flat PR tax of 5%, and the US federal government will not pursue a capital gains tax.

Example 1 – Within 10 years

  • A stock is acquired by a US resident for $100 in 2006
  • The stock is worth $200 in 2012, just before the US resident moves to Puerto Rico
  • The stock is sold by the now Puerto Rican resident in 2019 for $300
Cost: $100US TaxPR Tax
“Non-PR Built-in Gains”: $100 = $200 – $100U.S. long term cap gains (23.8%: $23.80)0%
“Puerto Rico Gain”: $100 = $300 – $200N/A0% Act 22

Example 2 – After 10 years

  • Using the same scenario in Example 1
  • The stock is instead sold by the now Puerto Rican resident in 2023 for $300
Cost: $100US TaxPR Tax
“Non-PR Built-in Gains”: $100 = $200 – $1000%P.R. special rate (5%: $5)
“Puerto Rico Gain”: $100 = $300 – $200N/A0% Act 22

There are two types of securities you may need to establish a tax basis for:

  1. Publicly traded security (marketable) – to determine the amount of “Non-PR Built-in Gains” versus “PR Built-in Gains”, best practice is to take a snapshot of the asset price on the day you moved. You cannot import Non-PR Built-in Gains to Puerto Rico and treat those gains as Puerto Rican sourced income. You can only treat appreciation on publicly traded securities in excess of the amount Non-PR Built-in Gains as Puerto Rican source income.
  2. Privately held business interest (non-marketable) – to determine the amount of “Non-PR Built-in Gains” versus “PR Built-in Gains”, the investor is responsible for setting that valuation. The investor would apportion that gain as either Non-PR or PR based on the numbers of days the asset has been held in each location. Said another way, this calculation is the percentage of all days the asset has been held while living in PR as Puerto Rican sourced income.

How Do You Get the Tax Exemption Decree?

The individual needs to submit an application with the Office of Industrial Tax Exemption (OITE) of Puerto Rico to obtain a tax exemption decree, which will provide full detail of tax rates and conditions mandated by the act. This decree is considered a contract between the government of Puerto Rico and the individual investor. Once the individual investor obtains the tax exemption decree, the benefits granted will be secured during the term of the decree, irrespective of any changes in the applicable Puerto Rico tax laws. The term of the decree will be until December 31, 2035, at which point you will need to accrue and realize any benefits.

How much does Act 22 cost?

  • Application fee: $750
  • Acceptance stamps: $150
  • Acceptance fee: $5,000 (one time)
  • Annual donation to a PR non-profit: $5,000 (required before Dec 31 in the year you accept your decree). This is in addition to the acceptance fee
  • Annual compliance filing: $300

Where is Your Income Sourced From?

Determining where your income is sourced will dictate where you file a tax return. In determining if Puerto Rico is right for you, and because tax rates vary, it is critical to know if the US or PR has authority. In general, the rules in the US apply to all US possessions, like Puerto Rico.

General Rules for Determining U.S. Source of Income Source (IRS Table 2-1);

Item of IncomeFactor Determining Source
Salaries, wages, and other compensation for labor or personal servicesWhere labor or services performed. If split between two locations, a time basis is applied.
PensionsContributions: Where services were performed that earned the pension
Investment earnings: Where pension trust is located
Investment income – InterestResidence of payer
Investment income – DividendsWhere the paying corporation is created or organized
Investment income – RentsLocation of property
Royalties: Natural resources, patents, copyrights, etc.Location of property where property is used
Sale of business inventory—purchasedWhere items were sold
Sale of business inventory—producedAllocation if produced and sold in different locations
Sale of real property

(editor’s note: contact us if you are considering an opportunity zone to defer real estate related gains).

Location of property
Sale of personal property

(editor’s note: this includes stocks and some cryptoassets).

Seller’s tax home (see Special Rules for Gains from Dispositions of Certain Property for exceptions)
Sale of natural resourcesAllocation based on fair market value of product at export terminal

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Contact us to save time, money, and headaches related to your Act 22 application – you’ll thank us later.

Resource: Act 22 Law – HB3627

Resource: PRIDCO Act 22 Overview

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