Puerto Rico Tax Residency

In recent years, Puerto Rico has become one of the most prominent locations for U.S. citizens to relocate to. A major attraction has been the generous 100% local tax exemptions for Puerto Rico-source interest and dividends, as well as capital gains, introduced originally under Act 20 and Act 22 and now consolidated under Puerto Rico Act 60 (The Tax Code of Puerto Rico).

Under 26 U.S.C. § 933, income derived from sources within Puerto Rico by an individual who is a bona fide resident of Puerto Rico for the entire tax year is generally excluded from U.S. federal gross income and exempt from U.S. federal income tax. Capital gains accrued after attaining bona fide Puerto Rico residency benefit from a 100% tax exemption from both U.S. and Puerto Rico taxation.

Puerto Rico is one of fourteen U.S. territories or possessions, only five of which are permanently inhabited (Puerto Rico, Guam, U.S. Virgin Islands, American Samoa, and Northern Mariana Islands). The Internal Revenue Code applies distinct tax rules for residents of Puerto Rico compared to residents of the 50 U.S. states.

Internal Revenue Code Section 933 does not exempt residents of Puerto Rico from paying U.S. federal taxes on U.S.-source income or foreign-source income. In general, dividends are sourced to the location of the paying corporation under 26 U.S.C. § 861(a)(2), while interest amounts are sourced to the residence or country of incorporation of the obligor under 26 U.S.C. § 861(a)(1).

The Three-Part Statutory Test for Bona Fide Puerto Rico Residency

Under 26 U.S.C. § 937 and Treasury Regulation § 1.937-1, an individual is treated as a bona fide resident of Puerto Rico during a taxable year if three distinct statutory tests are satisfied:

Understanding the 5 Alternative Presence Tests

To satisfy the physical presence requirement under IRC § 937(a), you must meet at least ONE of the following five alternative tests during the tax year:

Under the No Significant U.S. Connection Test, a taxpayer is deemed to have a significant connection to the U.S. if: (1) they maintain a permanent home in the U.S. (including a furnished room or leased apartment held available for long durations); (2) they hold an active voter registration in any U.S. political subdivision; or (3) they have a spouse or minor child under age 18 whose principal place of residence is in the U.S. (unless living under a custody decree or attending school as a full-time student). See Treas. Reg. § 1.937-1(c)(5).

How Days Are Counted for Puerto Rico Presence

Under 26 U.S.C. § 7701(b)(7)(A) and Treasury Regulation § 1.937-1, presence in Puerto Rico at any time during a calendar day counts as a full day of presence in Puerto Rico.

If you are physically present in both the United States and Puerto Rico during the same calendar day (e.g., a flight travel day), that day is counted as a day of presence in Puerto Rico. In addition, days spent outside Puerto Rico for qualifying medical treatment for yourself or immediate family members, or due to mandatory government evacuations or major disaster declarations, can also count as days in Puerto Rico under specific conditions in Treasury Regulation § 1.937-1.

The Tax Home and Closer Connection Requirements

The Tax Home Test: You cannot maintain a tax home outside Puerto Rico during any part of the tax year. Under IRC § 911(d)(3), your tax home is your regular or principal place of business, employment, or post of duty. If you do not have a regular place of business due to the nature of your trade or retirement, your tax home is where you regularly reside.

The Closer Connection Test: You must maintain more significant personal, economic, and social ties to Puerto Rico than to the U.S. or any foreign country. When evaluating your closer connection, tax authorities and courts inspect:

• Location of your primary, permanent family home;
• Location of your spouse, children, and immediate family;
• Location of active social, political, cultural, professional, or religious affiliations;
• Location where routine personal and business banking is conducted;
• Jurisdiction issuing your primary driver's license and vehicle registrations;
• Charitable organizations to which you actively contribute; and
• Official state of residence designated on tax filings, estate documents, and contracts.

IRS Form 8898 Filing Requirements

Under Section 937(c) of the Internal Revenue Code, individuals who establish or cease bona fide residency in Puerto Rico or another U.S. territory must file IRS Form 8898 (Statement for Individuals Begins or Ends Bona Fide Residence in a U.S. Possession).

Form 8898 must be filed for any tax year in which you meet both of the following conditions:

1. Your worldwide gross income for the tax year is more than $75,000; AND
2. You take a position for U.S. tax purposes that you became or ceased to be a bona fide resident of Puerto Rico (or another U.S. territory like the U.S. Virgin Islands, Guam, or CNMI).

IRS & GAO Compliance Scrutiny: Avoiding Audit Pitfalls

Establishing Puerto Rico tax residency requires strict, ongoing compliance. The U.S. Internal Revenue Service maintains an aggressive Large Business & International (LB&I) Active Campaign on Puerto Rico Residency to audit high-net-worth individuals claiming Act 60 benefits without satisfying physical presence or income sourcing rules.

Reinforcing this enforcement focus, a comprehensive December 2025 GAO Report highlighted ongoing gaps in data sharing between Puerto Rico tax authorities and the IRS, recommending systematic data exchanges and expanded mandatory audits of Act 60 decree holders.

Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own qualified tax, legal, and accounting advisors before engaging in any transaction or relocation.