All of us living in Costa Rica have been following the latest news on the imminent approval in Congress of a new tax bill introduced by the Chinchilla administration which contains substantial amendments to our current tax legislation. Much of the latest discussion in the media has focused on the discouraging effect of these reforms for foreign direct investment, with an emphasis on free trade zones. It is however a bit disconcerting to me that less attention has been granted to an equally important sector of the economy for our country: the real estate business.

How important is the real estate industry for Costa Rica? A great lot. During the last decade, foreign direct investment in real estate grew from nihil to becoming the second most relevant source of FDI for our country, not far behind the manufacturing/export industry, and certainly more significant than tourism. It peaked, just before the recession burst the bubble, at an amazing USD $650 Mn by the end of 2007, amounting for 40% of the total FDI. During that same period, Guanacaste was the province with the fastest growth in both construction and the second home market. Logically, this was also the province that suffered the most of the world economic crisis, as the real estate industry was –because of its dependence on foreign investment- the most seriously affected. Today, entering into 2012, this industry is barely and slowly recovering and hope is just timidly beginning to build up again in the heart of Guanacaste residents.

Dramatically and ironically the new Tax Bill severely targets the real estate industry and scares FDI away. Let me explain just how it does that.

Let’s start with the tax on capital gains. Today, non-recurrent real estate sales are simply not taxed, while recurrent sales (typically, by a real estate developer) would be taxed at a scaled rate. With the proposed amendments, all real estate capital gains would be taxed, with either 15% (single non-recurrent sale) or more likely 30% (if it’s recurrent or linked to its business activity). Therefore, less incentive to develop or to buy real estate, as prices would go up to make for the new taxes.

But that’s not all. In the case of leases, with today’s law those would normally not be subject to capital gains. However, once the new law is in place, monthly rent received from even a single leased property would be subject to a 30% capital gains tax. Worse still, any short term rents, and long term rents over $1,200 monthly would also be taxed with 14% Value Added Tax. A direct hit to those second home owners and investors who usually rent their condo or house for the most part of the year!

If you’re not worried by now, just wait until you hear this: All real estate related services (such as property management, real estate agency/brokerage, and legal) will be taxed with VAT at 14%, thus causing real estate transactions and ownership itself to become more expensive, and our market also less appealing to foreign buyers.

Last, but not least, the Bill also doubles the transfer tax on real estate from the now current 1.5% of the purchase price to 3%.

I’ll let you draw your own conclusions.