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The tax-neutral transfer of real estate assets to children

For owners of a property the question of transferring it for no consideration during their lifetimes is frequently of great importance. Besides the tax-based opportunities, such as for example, taking advantage of the gift and inheritance tax allowances, in some cases several times, other motives could be to avoid disputes between the children or to prevent the entitlement to a compulsory share being asserted. Then again, the financial security of the donors has to be ensured during their lifetimes. In the following section we provide an overview of the structuring options that would minimise the tax burden.

Basic principles

While the same principles apply to both inheritance tax and gift tax, nevertheless, the concessions could be more far reaching in the case of gifting. It is basically true to say that the gifting of a property out of private assets requires certification by a notary. In both succession and gifting cases, the property has to be recorded at its fair market value. Although, in the case of gifting, the assessment basis can be reduced by agreeing considerations in order to be able to make the best possible use of the existing tax allowances. In general, it is only the amount that exceeds the tax allowance of €400,000 per child and parent that has to be taxed, at the applicable rate, in accordance with Section 19(1) of the Inheritance Tax Act (Erbschaftsteuergesetz, ErbStG). This tax-exempt allowance may be used again every ten years. Possible and frequently used ways of reducing the assessment basis involve considerations in the form of a usufruct or granting the right of residence – these leave the transferors financially secure. In the case of a property rented out for residential purposes as defined in Section 13d(3) ErbStG, the fair market value of the property would be reduced by a flat rate of 10% if the narrow criteria stated in the Act have been fulfilled.

Right of usufruct

Parents who opt for gifting under a reservation of the right of usufruct retain their right to use the asset that they have donated. They continue to have the right to rent out the property, to retain the rental income and, under income tax law, to deduct property-related expenses as costs related to income from letting and leasing. Although, the sale or encumbrance of the property would be conditional on the approval of the children. The usufruct has to be entered into Section II of the land register (Grundbuch).

The main advantage of using right of usufruct is that the value of the usufruct would be deducted from the donation value and, consequently, the taxable base could be reduced considerably. The cash value of a usufruct is calculated on the basis of the net income of the property and the age of the parents. If ten years have elapsed since the donation was made then, in a succession case, this transfer would not be taken into consideration. Although, this period begins on the date when the donor has relinquished his/her right of use. If the aim is to reduce the compulsory share to which a legal heir would be entitled, normally, the right of usufruct does not lead to the desired outcome.

Please note: Furthermore, it should be borne in mind that the subsequent waiver of the right of usufruct constitutes an event that could be liable to gift tax. A waiver would be regarded as a new donation between the persons involved in the original transfer. In such a case, it also has to be taken into account that the value of the right of usufruct could, over the course of time, turn out to be higher than the value deducted in the context of the asset transfer due to, for example, an increased income situation.

The right of residence

The main difference here when compared with usufruct is that the property may only be used by the donors themselves. The formal requirements and the general conditions correspond to those for usufruct. In case of doubt, usufruct is preferable to the right of residence because of its greater flexibility.

(Partial) remuneration

Partial remuneration would occur, for instance, if in the course of the transfer of the property liabilities were also passed on to the beneficiary. This is usually the case with plots of land and properties that are encumbered. Here, the transfer would have to be divided between the portion for payment and the one for no payment. The apportionment would be performed on the basis of the ratio of the payment to the fair market value of the property.

  • If a property were transferred in return for payment under a reservation of usufruct then the depreciation would be measured according to the cost of the acquisition for the owner. In this case, the cash value of the usufruct would not be included in the cost of the acquisition. The depreciation volume would have to be reduced by the amounts of depreciation in the owner’s acquisition costs that relate to the period between the acquisition of the property and the expiry of the usufruct.
  • By contrast, if the property were transferred for no payment made under a reservation of usufruct then, after the usufruct has expired, the owner would continue with the depreciation schedule of the predecessor-in-title (in this case the transferor).

Recommendation: Early planning would be worthwhile for larger assets in view of the tax allowances, which may be used again every ten years. Prior to any agreements, the effects of a right of usufruct should be thoroughly analysed and calculated so that no nasty surprises can emerge out of this. In view of the individual personal, tax and legal requirements that are involved it is absolutely essential to obtain comprehensive advice.

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