date | theme

24. July 2019 | Saving inheritance tax through chain gifting: deadlines and criteria

10. February 2021 | Property swing – transferring assets to spouses without gift tax

04. May 2021 | Empowerment needs test and save inheritance tax

15. December 2021 | Avoid gift tax when gifting large assets

30. March 2022 | Designing asset succession with real estate – tax-free! (this contribution)

If you want to make a property succession tax-free, then real estate is particularly suitable for this. This is because real estate can receive a value in the valuation under the inheritance or gift tax that is significantly lower than that of the purchase price. As a result, a large part of the actual taxable assets can already be exempted from taxation. The remaining asset can also be compensated by a loan with which the purchase of the real estate is financed externally. In this way, no assets remain that could be subjected to taxation under the inheritance or gift tax. However, this model strongly depends on the choice of the evaluation method. In the case of an evaluation within the framework of the comparative value method, however, a reduced value determination is largely excluded. The income value method and the property value method are significantly better suited because the valuation operates here with partly obsolete value approaches.

High-net-worth individuals who are concerned about the succession of assets understandably want to find a way with which a tax-favorable transfer of their assets can take place. There are many methods available here. In fact, especially in the area of gift and inheritance tax law, tax structuring is both very far-reachingly possible and legally well secured.

One of these possibilities is linked to real estate. Because if you want to design the property succession with real estate, then there is the prospect of avoiding the inheritance or gift tax altogether. In a particularly favorable case, one even manages to generate a negative asset, which can then be used for the tax-free transfer of further assets. In this article, we would therefore like to show you an example of how tax-advantageous asset succession can be made with real estate.

So much has already been revealed: Our model, with which we want to design asset succession with real estate, is related to the valuation. After all, this is a very general trick when it comes to taxing assets. Because if you can prove that you have no significant assets, the tax is also advantageous. In the best case, taxation can therefore be avoided completely by evaluating the tax object.

This is why we first deepen our knowledge a bit with regard to the valuation of assets. And since we want to design the asset succession with real estate in this article, we should first deal with their valuation. In principle, there are three valuation methods with which real estate is valued for tax purposes. The valuation law (BewG) specifies the so-called comparative value method, the simplified yield value method and the property value method.

The comparative value method compares the value of a particular property with the sales proceeds of a comparable property on the market. This gives you a good idea of the actual value of a property. Conversely, a tax arrangement is rather excluded here. After all, the goal of our design is to find the lowest possible value approach. The orientation towards the market value is therefore not very helpful.

In the income value method, things already look much cheaper. If no direct comparisons are possible, for example because the properties to be valued are located in a region where there is rarely a sale of comparable properties, then you have to use a different valuation methodology.

The income value method is quite recognized, because you can use the income that a property can potentially generate to determine the value of the property. These potential rentals are taken from the property market report when assessing them. However, they are usually lower than the current rents. However, since interest on real estate can still be used at legally regulated real estate interest rates of currently around 5 %, the value of the real estate is significantly lower. But also the soil benchmark, which is also included in the valuation, is usually significantly lower than the current square meter prices on the real estate market. Therefore, this also contributes to a lower valuation.

In this way, the valuation results in a property value relevant for taxation, which corresponds to approximately 50 % of the market value.

However, the valuation can be made even lower in the context of the property value procedure. This is also done using partially outdated standards based on value ratios from 2009. As a result, they entail a valuation of the properties which, in particularly favourable circumstances, represents only 30 % of the actual market value. However, the asset value method can only be applied in certain situations.

We can now use this discrepancy due to the different valuation methods to design asset succession with real estate. Let us give two examples to illustrate the principle. The key point here is that a wealthy person, let’s call her Mrs. Reichling, wants to give her niece part of her wealth. Whether this should ultimately be done in the context of a gift or by inheritance is in principle irrelevant. But we want to start from a gift for another reason, which we will explain later. In any case, based on our tax design model, Ms. Reichling plans to transfer EUR 5,000,000 to her niece.

In a first step, Ms. Reichling is looking for a property in a city or municipality where she can assume that she can exclude the comparative value method when valuing it. In addition, the property should cost around EUR 10,000,000. Furthermore, Ms. Reichling takes out a loan to finance the purchase. The loan is to cover 50 % of the purchase price and thus amount to EUR 5.000.000. If the purchase of the property is completed, Ms. Reichling can prepare the gift of the property to her niece.

When calculating the gift tax, the tax office performs the income value method as expected. The authority comes to the conclusion that the property has a taxable value of EUR 0. This is because the valuation methodology results in a property value that is only 50 % of the original purchase price. Instead of a wealth of EUR 10,000,000, one would now have to subject EUR 5,000,000 to taxation for gift tax. However, the loan as a fully usable liability completely exhausts the value established in the property valuation. From a tax point of view, the result is that there is no wealth to be taxed.

But it can come even better. Let us simply assume the same situation. The only difference here should be the level of the evaluation. If we realistically assume that by applying the property valuation method we arrive at a slightly lower valuation of the property, which in our example only quantifies 45% of the purchase price as an asset, then it follows that instead of an asset, only debts pass to the niece. The calculated debts associated with the transfer of the property amount to EUR 500,000.

So Mrs. Reichling could also give her niece other values in this amount, without this leading to a gift tax. For example, Ms. Reichling could also transfer an expensive car or valuable art to her niece, the value of which is EUR 500,000. Because the offsetting of assets and liabilities over the calculation of the gift tax is quite allowed. After all, this is about taxing a group of assets instead of taxing individual assets. This circumstance can also be used when designing the asset succession with real estate for the benefit of the gifted.

The tax advantages that emerge here are obviously enormous. You can also operate with completely different values. Depending on the loan share of the property purchase price with which the debt financing is tailored, the tax advantages can be even greater. In the current low-interest phase on the capital market, this is quite realistic. In this way, you could even transfer more assets tax-free than you invest in the property yourself.

However, you also have to negotiate skillfully with the banks or other lenders. Finally, when granting a loan, lenders bind to a specific person for whom they have established the credit rating. However, if a change of the borrower takes place through the donation, then a completely different credit rating has become relevant. This could have consequences for borrowers under certain circumstances. Therefore, this should be clarified with the donors beforehand. At the very least, the argument that a change of borrower would also take place in the case of an inheritance should strengthen one’s own position.

However, when attempting to arrange the property succession with real estate in the manner described, there is a risk that the tax office could nevertheless carry out a higher valuation of the real estate assets than foreseen for the implementation of the plan. This may be due, for example, to the fact that, contrary to expectations, sufficient basics are available for an evaluation in the comparative value method. Nevertheless, one can also provide for such a case. For this purpose, a clause is included in the gift contract that reverses the gift if it leads to an accumulation of the gift tax. In such a case, Ms. Reichling would simply keep the property and could then go in search of more suitable properties with which she can try to redesign the asset succession.

If you want to design the asset succession with real estate, then a tax-free transfer of the assets is quite feasible. This succeeds even if no use of the protection requirements test in the sense of the gift and inheritance tax law is possible. Even if this were the case, the model proposed here would have the advantage of not applying retention periods or other conditions.

In addition, asset succession with real estate in the variant discussed here is also suitable in combination with other tax saving models. For example, you can also insert a usufruct into this model.

But it is certainly also advantageous that you can design a gift contract with all kinds of precautions, so that you can regain control of the transferred assets if necessary. This protection works even in the event of an unexpected gift tax occurrence. Only in the case of inheritances is this risk management without effect. Therefore, the model for asset succession with real estate is best if you intend to design a gift.

The basic conclusion, however, is that the model only works if the valuation of the real estate to be transferred must always lead to a certain value reduction, so that the debt financing neutralizes the value determined by the valuation. Here you can still catch a part of the value with any available free amounts. But these are only minor details when it comes to asset succession in the order of several million euros.