My Sunny and Warm Tax Haven

After spending a few days recently in the warmth of Miami, I always wonder why I do not live in (or retire to) a part of the country where this weather is common all year long. And since I am a fan of the beach, having a coastline would be nice, too. At first I thought about California, but it’s far away from friends and family, has earthquakes, that three-hour time zone issue, and it’s one of just a handful of states that’s actually more expensive to live in from a tax perspective (sorry, I am a CPA at heart) than Maryland. So, I progressed on to my most recent vacation choice, Florida. It does solve the distance, time zone, and tax issues (no state income tax!), yet substitutes hurricanes for earthquakes, can get humid, and is pretty crowded “in season.” I was running out of options when I thought of a place a bit off the beaten path, but one that still offers some amazing possibilities (especially from a tax perspective), and that would be Puerto Rico.

Before you just dismiss me out of hand, let’s go over some quick facts about the island:

  • As a commonwealth of the U.S., it has a governor that runs the government locally, but the head of state is currently the President of the United States, Joe Biden. This also means that you don’t have to consider giving up your U.S. citizenship to live there.
  • Related to the point above, U.S. citizens can travel freely to the island with no passport or visa required.
  • The official languages are Spanish and English (just like Florida).
  • The average temperature year-round is near 80 degrees Fahrenheit.
  • It generally shares the same time zone as Washington, D.C. (not during daylight savings time, but since Puerto Rico does not recognize daylight savings time, at least you don’t have to change the clocks twice a year).
  • Health and medical facilities are generally comparable to those in the U.S.
  • Real estate prices are also generally comparable to the U.S.

In general, residents of Puerto Rico do not pay Federal U.S. taxes, they pay Puerto Rico taxes. Historically, these rates have been comparable to U.S. rates. However, the Individual Investors Act (Act No. 22-2012 as amended), originally passed in 2012 by the legislative assembly of Puerto Rico, has changed all of that. This bill exempts “passive income” (in this case, interest, dividends, and certain capital gains) for new residents from taxation during an “Exemption Period” running until the end of 2035. The purpose of this measure is to provide an incentive for individuals to become residents of Puerto Rico and positively impact the local economy by investing in real estate, buying local products and services, etc.

So, if you were to move (or retire) to Puerto Rico, you would not pay Federal U.S. taxes nor Puerto Rico taxes on passive income, which equates to it being tax-free. In my old life at Andersen, I had clients set up domicile in Florida to avoid paying roughly 8% state taxes on an expected large capital gain transaction. Would those same clients have been willing to move to Puerto Rico to avoid the other roughly 24% Federal tax? Would you?

In order to qualify for the Act’s provisions, you must first establish domicile in Puerto Rico (and not have been a resident for the past 10 years preceding the passage of the Act). This can generally be established by spending more than 183 days on the island, or can also be determined by numerous “facts and circumstances” used by taxing authorities such as (but not limited to):

  • Driver’s license and voting registration
  • Location of bank accounts
  • Location of family physicians
  • Address used for bills and subscriptions
  • Location of clubs and places of worship

You must request a tax exemption decree from the Secretary of Economic Development and Commerce which acts as a contract between you and the Puerto Rican government. This exemption would apply to passive income recognized during the period that begins when you establish domicile in Puerto Rico and ends on December 31, 2035. After this date, you would be taxed just like any other Puerto Rico resident.

One caveat to the law is that the portion of long-term capital gains attributable to the period before establishing domicile in Puerto Rico would be subject to a Puerto Rico capital gain tax rate of 10%. However, this “pre-domicile” gain is reduced to 5% if held for 10 years from your date of domicile in Puerto Rico.

Now, there are obviously many other factors to review when considering a potential relocation, and my list above is hardly comprehensive. Do I really expect many of you to drop everything and move to Puerto Rico to save a bit of taxes? Not really, but it is an option. If only they could do something about the potential for hurricanes.

As always, please consult your accountant, tax attorney, or other financial professional to discuss your specific circumstances before taking action.

Wealthspire Advisors is the common brand and trade name used by Wealthspire Advisors LLC and its subsidiaries, separately registered investment advisers and subsidiary companies of NFP Corp.
Please Note: Limitations. The achievement of any professional designation, certification, degree, or license, recognition by publications, media, or other organizations, membership in any professional organization, or any amount of prior experience or success, should not be construed by a client or prospective client as a guarantee that he/she will experience a certain level of results or satisfaction if Wealthspire is engaged, or continues to be engaged, to provide investment advisory services.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, Certified Financial Planner™, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
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Bill Schwartz

About Bill Schwartz, CPA, CFP®

Bill Schwartz is a managing director in our Potomac, Maryland office.

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