Puerto Rico Bona Fide Residency & the Source-of-Income Rules

General informational introduction, current as of June 2026. For educational purposes only — not legal or tax advice, and not a substitute for advice from qualified counsel about your specific facts.

If you are considering relocating to Puerto Rico to take advantage of Act 60, there is a threshold question that matters more than the decree itself: are you a “bona fide resident” of Puerto Rico for federal tax purposes? The Act 60 decree is a Puerto Rico instrument that fixes your Commonwealth tax treatment. The far larger federal benefit — excluding Puerto Rico-source income from your U.S. return — comes from a separate set of Internal Revenue Code provisions and depends entirely on qualifying as a bona fide resident under IRC §937. Get residency wrong and the federal exclusion disappears, no matter what your decree says.

This guide explains the two-layer framework, the three residency tests every applicant must satisfy, and the source-of-income rules that decide how much of your income the exclusion actually reaches. It is written for prospective Act 60 applicants and the advisors who serve them.

1. Why Bona Fide Residency Matters: A Two-Layer Framework

A United States citizen is taxed on worldwide income regardless of where they live. Moving to a U.S. territory does not, by itself, change that. The federal benefit comes from a narrow set of Code provisions — IRC §§931–937, and, for Puerto Rico, the income exclusion of IRC §933 — that remove certain territory-source income from federal gross income, but only for an individual who qualifies as a bona fide resident of the territory.

Bona fide residency is therefore the gateway. Without it, the federal exclusion does not apply at all, and a Puerto Rico Act 60 decree confers only Commonwealth-level benefits. The provisions reach five territories: American Samoa, Guam, the Northern Mariana Islands, Puerto Rico, and the U.S. Virgin Islands (Treas. Reg. §1.937-1(a)(2)(i)).

Two structural features matter throughout. First, residency is tested year by year. Qualifying one year does not lock in any other. Second, it is essentially binary — a taxpayer either is or is not a bona fide resident for the taxable year (subject to a limited year-of-move rule, discussed below). Only natural persons can qualify; corporations, partnerships, trusts, and estates cannot (Treas. Reg. §1.937-1(b)(3)).

2. The Three Tests at a Glance

IRC §937(a) and Treas. Reg. §1.937-1 impose three requirements, all of which must be satisfied for the same taxable year: (1) the presence test, (2) the tax home test, and (3) the closer connection test. The presence test is mechanical day-counting; the tax home and closer connection tests are qualitative and overlap heavily with one another. Failing any single test means the individual is not a bona fide resident for that year — and forfeits the federal exclusion for that year.

3. The Presence Test (Treas. Reg. §1.937-1(c))

A U.S. citizen or resident alien satisfies the presence test for a year by meeting any one of five alternatives:

1. Present in Puerto Rico for at least 183 days during the taxable year (the standard test, and the cleanest profile).
2. Present in the territory at least 549 days over the three-year period of the current and two preceding years, with at least 60 days in the territory in each of those three years.
3. Present in the United States no more than 90 days during the taxable year.
4. Had no more than $3,000 of U.S. earned income (the figure in §861(a)(3)(B); “earned income” per §1.911-3(b)) and spent more days in the territory than in the United States.
5. Had no “significant connection” to the United States during the taxable year.

How days are counted

You are present in Puerto Rico on any day you are physically there at any time, and present in the U.S. on any day you are physically in the U.S. at any time. A day spent in both the U.S. and Puerto Rico counts as a territory day. Several U.S. days do not count against you — days as a student, qualifying medical-treatment days, transit days of under 24 hours between two foreign points, days competing as a professional athlete in a charitable event, and days serving as an elected or appointed territorial official. Conversely, days spent outside Puerto Rico to receive (or to accompany a parent, spouse, or child receiving) qualifying medical treatment, and days lost to a federally declared major disaster or mandatory evacuation, are counted as territory presence — subject to specific documentation requirements (Treas. Reg. §1.937-1(c)(3)–(4)).

What counts as a “significant connection” (alternative 5)

A taxpayer has a significant connection to the U.S. if they have (a) a permanent home in the U.S., (b) current U.S. voter registration, or (c) a spouse or minor child (under 18) whose principal place of abode is in the U.S. (with narrow custody and student exceptions). A property rented out to others is generally not a “permanent home” unless the taxpayer also uses it as a residence (Treas. Reg. §1.937-1(c)(5)). Nonresident aliens use a different rule, substituting substantial-presence principles applied to the territory (§1.937-1(c)(2)).

What compliance looks like

Keep a contemporaneous travel log and day count; retain boarding passes, calendars, and travel records. If you rely on medical or disaster days, assemble the physician certification and supporting records the regulation requires and be prepared to produce them within 30 days of an IRS request.

4. The Tax Home Test (Treas. Reg. §1.937-1(d))

You must not have a tax home outside Puerto Rico during any part of the taxable year. “Tax home” uses the principles of §911(d)(3): it is your regular or principal place of business. If there is no such place — because of the nature of the business, or because you are not carrying on a trade or business — the tax home is your regular place of abode in a real and substantial sense. In practice, a worker or business owner generally needs their principal place of business in Puerto Rico, while a retiree or passive investor needs their main home there.

Note the “any part of the year” standard — this is stricter than the presence test, which is measured over the whole year. Limited exceptions exist for seafarers and for disregarded student/government-official days, and the year-of-move rule relaxes the full-year requirement for the transition year. Compliance means genuinely locating the principal place of business in Puerto Rico (office, clients, where the work is actually performed) or, for non-business individuals, making the island the true center of home life.

5. The Closer Connection Test (Treas. Reg. §1.937-1(e))

You must not have a closer connection to the United States or a foreign country than to Puerto Rico during any part of the year. This applies the factors of §7701(b)(3)(B)(ii) and Treas. Reg. §301.7701(b)-2(d): the location of your permanent home; the location of your family; the location of personal belongings such as cars and furniture; social, political, cultural, and religious affiliations; business activities (other than those constituting the tax home); the jurisdiction that issued your driver’s license; where you are registered to vote; and the jurisdiction listed as your residence on official forms.

The comparison is Puerto Rico against the aggregate of your U.S. and foreign connections, and it is a totality-of-the-circumstances test — no single factor controls. The regulation’s own Example 7 (a taxpayer who relocates but keeps his family, home, driver’s license, voter registration, and banking on the mainland) shows how readily this test fails even when the person spends real time on the island. Compliance means moving the indicia of life to Puerto Rico: driver’s license, voter registration, family, vehicles and belongings, bank and professional and religious affiliations, and mailing address.

6. How the Presence-Test Alternatives Affect the Other Two Tests

This is the central planning point, and where most prospective applicants are misled. Because there are five ways to clear the presence test, a taxpayer can technically satisfy presence while spending fewer than 183 days in Puerto Rico — even substantial time off-island. But the tax home and closer connection tests must still be met for the entire year, and the very facts that let someone use a non-183-day alternative frequently create tax-home and closer-connection problems:

• Alternative 3 (≤90 U.S. days) leaves room for large amounts of time in foreign countries or in the territory. That is fine for presence, but if the off-island time reflects a business or a home elsewhere, the tax home or closer connection test can fail.
• Alternative 4 (<$3,000 U.S. earned income + more territory days than U.S. days) is illustrated by the regulation’s Example 2: a retiree with only 175 territory days, a U.S. vacation home, and more than 90 U.S. days flunks the 183-day count yet meets presence under alternative 4. She must still independently clear tax home and closer connection — and that U.S. vacation home is exactly the kind of fact that threatens the closer connection test.
• Alternative 5 (no significant connection) is defeated by a U.S. permanent home, U.S. voter registration, or a minor child living stateside. Those same facts are also strong evidence of a closer U.S. connection — so a single fact can sink two tests at once.
• Alternative 2 (549 days over three years) can let a low-presence year (as few as 60 territory days) qualify on presence, but a 60-day year is very hard to reconcile with having one’s tax home and closest connections in Puerto Rico.

Bottom line: the presence test is the floor, not the finish line. Whichever alternative you use, you must independently satisfy the tax home and closer connection tests for the whole year, and choosing an alternative that tolerates more time or more ties off-island raises your risk under the other two tests. The cleanest profile remains 183-plus territory days with home, business, family, and personal indicia all genuinely relocated.

7. The Year of the Move (Treas. Reg. §1.937-1(f))

A special transition rule can treat a person as a bona fide resident for the part of the year following a move (Puerto Rico has its own variant for the year of departure). It generally requires that the individual was not a resident in the three preceding years, satisfied the tax home and closer connection tests for the last 183 days of the move year, and is a resident for the three following years. The rule should never be assumed — it must be checked against your actual move timeline.

8. The General Source-of-Income Rules

Once residency is established, the next question is which income is territory-source (eligible for the exclusion or the Act 60 rate) and which remains U.S.-source (still federally taxable). IRC §937(b) and Treas. Reg. §1.937-2 apply the ordinary U.S. source rules of §§861–865 to Puerto Rico, generally by substituting the territory for “the United States.” Two overlays are critical: (i) the U.S.-income rule — income that is U.S.-source or U.S.-effectively-connected under §§861–865 can never be territory-source (§937(b)(2); Treas. Reg. §1.937-2(c)); and (ii) an anti-conduit rule plus a cap that prevents a resident from generating more territory-source income than a similarly situated nonresident would have U.S.-source income.

The principal categories:

• Capital gains — residence of the seller. Gain on the sale of personal property, including securities, is sourced to the seller’s residence (§865(a)). A bona fide Puerto Rico resident’s gains are therefore generally territory-source. Caveat: appreciation that built up before the move, on assets held before the move, is generally treated as U.S.-source even if sold afterward, unless a special mark-to-market election is made (Treas. Reg. §1.937-2(f) — the “10-year lookback”).
• Interest — residence of the payor. Interest is sourced to the residence of the obligor that pays it, not the recipient (§861(a)(1)). Interest paid by a U.S. person or U.S. corporation is generally U.S.-source regardless of where the recipient lives.
• Dividends — where the paying entity is organized. Dividends are sourced to the place of incorporation of the paying corporation (§861(a)(2)). A dividend from a U.S. (e.g., Delaware) corporation is U.S.-source no matter where the shareholder resides; relocating does not convert U.S. corporate dividends into territory income. This is the single most common point of client confusion.
• Real property — where it is located. Income from real property — both rents and gain on sale — is sourced to where the property is located (§861(a)(4)–(5)). Puerto Rico real estate produces territory income; mainland real estate produces U.S. income.
• Personal services — where performed. Compensation is sourced to where the services are physically performed (§861(a)(3)). Work done in Puerto Rico is territory-source; work done on the mainland is U.S.-source — which is why mainland working days matter.

Practical upshot: a portfolio of U.S.-corporate dividends and U.S.-issuer interest generally remains U.S.-source and federally taxable even after a successful move. The exclusion and the Act 60 rate bite hardest on territory-source capital gains (on assets acquired after the move), territory-source services, and territory-source business income.

9. Practical Takeaways

• All three tests must be met every year; the cleanest facts are 183-plus territory days plus genuine relocation of home, business, family, and personal indicia.
• The presence test is mechanical; the tax home and closer connection tests are where most disputes and audit risk arise.
• Source rules — not residency alone — determine how much income actually benefits. U.S.-corporate dividends and U.S.-payor interest stay U.S.-source.
• File Form 8898 to notify the IRS when beginning or ending bona fide residency (§937(c)), and maintain day-count and connection records contemporaneously.

Frequently Asked Questions

Related Resources

• The Three-Part Federal Residency Test Every Act 60 Decree Holder Must Pass — a focused compliance briefing on the presence, tax home, and closer connection tests, with the year-of-move safe harbor.
• Act 38-2026 (HB 505): What Changed for Act 60 Investors — the new 4% rate, grandfathering, and the federal 10-year lookback.
• IRS Enforcement & Campaign 685 — how residency and sourcing claims are audited and prosecuted.
• Federal Reporting: FBAR, FATCA & Form 8898 — the filings that survive your move.
• Estate Planning for Act 60 Decree Holders — coordinating residency with your estate plan.