date | theme

21. August 2020 | GmbH shares tax-free inherit or give away

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

19. January 2022 | Reduce gift tax through usufruct on capital gains

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

26. October 2022 | Transfer assets to children: 4 models in comparison (this post)

Wealthy parents should think as early as possible about the transfer of their assets to their children. Because if they wait until their children naturally acquire the property through inheritance, then the personal allowance of the children could turn out to be only small compared to the inheritance tax. Fortunately, inheritance and gift tax law offers a variety of ways to save on property succession taxes. Apart from the special exemption provisions regarding the transfer of undertakings (keyword conservation needs assessment), three alternatives are conceivable. On the one hand, you can transfer property to children with gifts tax-deferred. Among other things, a conditional usage is also advantageous here. On the other hand, one can regulate the property succession via a family GbR or a family foundation. This results in several tax advantages as well as optimization possibilities in order to exclude future disputes of the children from the outset.

When parents have assets, sooner or later they face the challenge of transferring it to their children. It is understandable if they intend to pass on the assets to the children, if possible without taxes. However, inheritance and gift tax law prescribes a number of regulations in this respect that at first glance make taxation of the transferred property inevitable. In fact, the inheritance and gift tax is a type of tax that has a large number of exemptions. In addition, you can achieve much more with a clever tax design. Therefore, in this article we present you four models and procedures in comparison. So we look at which taxes are incurred and which other conditions and advantages appear as special features.

Probably the most unneeded option for transferring assets to children is inheritance. Let’s take an example of an average family with two parents and two adult children. As assets we want to value EUR 4.000.000. If this property now belongs to only one of the parents and only the children are to assume the inheritance, in equal parts, then each child must tax a property of EUR 2,000,000. In principle, each child can deduct EUR 400,000 as an allowance. All other deduction options should be irrelevant to our considerations. Thus, the tax is due to an amount of EUR 1,600,000. The tax rate in tax class I used here is 19%. Consequently, in this variant, each child pays an inheritance tax of EUR 304,000.

It is obvious that parents could transfer their assets to their children more cheaply. Even if they were to share the assets equally among themselves, this would mean that each child could apply the tax exemption twice instead of only once. Thus, each child would save EUR 304,000 in taxes in this way alone. In addition, in this case, the tax rate of 15 % would also be slightly lower. Consequently, we expect an inheritance tax of EUR 90,000 for each of the two inheritances of EUR 1,000,000. Taken together, this leads to a sum of only EUR 180,000 instead of EUR 304,000 in inheritance tax per child.

The second possibility to transfer assets to children and which is also provided for in the Inheritance and Gift Tax Act is the donation (§ 1 paragraph 1 no. 2 ErbStG). Gifts are in principle subject to the same rules as inheritances. However, there is a special time frame (§ 14 paragraph 1 ErbStG). Because gifts within a period of ten years are tax-free up to the amount of the allowance. This means that every ten years you can transfer assets of EUR 400,000 to each child tax-free.

Now, if parents divide their assets and choose the gift path to transfer to their children, then all assets from our previous example can be transferred to the children tax-free within 21 years. So instead of either taxes in the amount of EUR 304,000 or EUR 180,000, which were incurred with assets of EUR 4,000,000, the children in this variant pay no taxes at all.

However, you can also make further optimizations in connection with donations. Because with a reserved usufruct, parents can achieve that the value of the property to be given away, which the children have to tax, falls significantly. For this, one must set as a condition for gifting that the parents receive at least a share from the income that the gifted property provides. Alternatively, private rights of use, such as a right of residence, can also be cited as a reserved usufruct. In any case, the value of the taxable property is reduced because the children are denied the full use of the property transferred to them.

We also have another option. It is particularly suitable if the parents want to transfer assets in the form of real estate to their children. The parents set up a GbR together with their children. The children are significantly involved in this family GbR, but the parents are entitled to the management. The parents then sell their properties from their private assets to the Familien-GbR. But they do not receive money in return. Instead, they are entitled to a claim against Familie-GbR in the amount of the selling price. You should set the price as high as possible, but it should also be realistic. Because now the GbR can gradually write off the property value. In this way, one can achieve that no taxes are incurred on the rental income. Consequently, a large part of the income can be used to pay off the parental claim.

As a side effect, parents are entitled to a market interest for their claim, which can be regarded indirectly as a loan. It is then capital income which is subject to flat-rate taxation with 25 % capital gains tax. So even the parents earn on this design. On the other hand, the interest rates lower the taxable profit, so that the family GbR also has to pay less tax.

Another plus point: You can design the social contract in such a way that the departure of a child from the family GbR does not offer any financial incentives. Alternatively, a minimum period for the duration of the shareholders can also be included in the company agreement.

Furthermore, it may stipulate that (future) spouses of the children either accept a waiver of participation in any form or, in the event of refusal, accept the exclusion of the child with whom they are married, provided for in the social contract for such cases, without financial advantage.

Incidentally, the sale of the real estate to Familien-GbR takes place without the imposition of the real estate transfer tax, because the persons involved in the GbR would not have to pay real estate transfer tax even in a private sale transaction between them.

With the fifth option, we are in principle taking the most radical step. Because here we actually transfer no assets to the children. Instead, we transfer it to a family foundation. Here, too, the parents build the foundation only with the minimum assets. They then sell their real estate or other income-producing assets to the Foundation in return for a claim against the Foundation. Of course, this demand should also bring interest to the parents and help the foundation save on taxes.

The highlight of this design, which manages without the transfer of assets to children, is that parents can shape the foundation statutes in a targeted manner. Of course, they use their children as destinataries. However, the regulations can go much further. For example, parents can cover their own pensions. Ultimately, however, asset succession is regulated over generations in such a way that all recipients of benefits are treated and cared for fairly, without any inconsistency among descendants. This is indeed a very common phenomenon in inheritance.

As a bottom line, we can state that all designs sometimes offer very clear tax advantages over asset succession by inheritance. But even among the design models one can notice differences. Thus, the transfer of assets to children by donation in the ten-year rhythm makes sense only if the assets to be transferred are easily divided (i.e. for many children) and thus passes on to the children relatively quickly, i.e. within one or two decades. Therefore, the property may have only a certain size depending on the applicable allowance. However, one must bear in mind that the risk of an unforeseen inheritance still exists. Because then, in the case of taxation, the last donation received to the tax base is added to the remaining assets to be inherited.

The family GbR is therefore cheaper, because the children in this scenario hardly inherit assets. At most, the interest her parents received from Familien-GbR on the basis of the purchase price claim could be relevant here. On the other hand, however, there is the significantly greater tax advantage implied by the depreciation on the transferred assets.

This is similar to the family foundation. Compared to the family GbR, however, there is another advantage here that asset succession is completely regulated across generations. However, in the case of a family foundation in Germany, it must be noted that according to § 1 (1) no. 4 ErbStG, a substitute inheritance tax applies every 30 years. Fortunately, this circumstance can be avoided by setting up a family foundation in Liechtenstein. With such a solution, even further advantages can be generated. For example, in this way, there is no double inheritance tax if a child should move to another country with which there is no double taxation agreement regarding inheritance tax. In fact, only in very few exceptional cases does such a double taxation agreement with Germany exist.