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Inheriting real estate tax-free: An insight into German inheritance law

A high-quality residential property is not only an investment with stable value, it also allows owners to leave something to the next generation that will last and which the beneficiaries can ideally even take over at full value. This is because, under the right conditions, not only can real estate in Germany be inherited tax-free, it can also be subsequently sold on tax-free.

Bettina Schneuer 11. January 2022 · Updated: 1. March 2022 · Reading Time: 6 Minuten

According to the German Inheritance Tax and Gift Tax Act (ErbStG)[1] basically all inheritance is taxable – at least in theory. In practice, the tax burden on inherited real estate is usually very low, as the heirs can claim allowances of between €20,000 and €400,000. For residential property inherited within the immediate family, there is even the option of avoiding inheritance tax altogether.

However, in order to maintain the value of a residential property over generations, it is necessary to observe a number of legal intricacies and, above all, holding periods. Otherwise, not only is the resale of an inherited property subject to income tax, in some cases inheritance tax may even become due retrospectively.

From tax allowances to speculation periods: Everything you need to know

Whenever private owners sell a property, it is known as a private sale transaction[2], and the taxation of the property is dependent on the sale or speculation period. This begins either with the construction or the purchase of a property and lasts ten years under German law, whereby the conclusion of the corresponding contract is decisive. In the case of a gratuitous acquisition as part of an inheritance, the acquisition date of the legal predecessor is decisive.

If owners sell a property within this period, they are subject to capital gains tax and income tax – and if it is an inherited property, between seven and 50 per cent inheritance tax may also be added depending on previous inheritance tax considerations.

However, when it comes to residential property being inherited, there are two scenarios that offer very different options for reducing the tax rate.

a) The owner bequeaths a rented residential property

Rented residential real estate is always subject to inheritance tax. For this reason, the inheritors of rented properties are obliged to inform the relevant tax office within three months of accepting the inheritance in accordance with ErbStG [3]. The tax office then assigns an expert to determine the value of the property. The basis for the valuation is laid down by law. Inheritance tax is due on 90 per cent of the determined value after deduction of all allowances.[4].

If the inheritors wish to sell a rented property, the sales period must also be taken into account: Sales within the first ten years after acquisition may be subject to income tax in addition to inheritance tax. However, this holding period can be shortened to three years if the owner used the property privately in the year of the sale and in the two years prior to that [5].

“However, personal use does not necessarily mean that the beneficiary themselves uproots their life to live in the apartment or house. Alternatively, they can use the property as a registered second home or leave it to one of their children free of charge for the three years, for example while they are completing an apprenticeship or studying,” says Dr Axel Schmitz, Managing Partner at RALF SCHMITZ. “Allowing a few years to pass before reselling can also have a very positive effect on the eventual sale – especially if it’s a high-quality property. The stronger the building structure and the more desirable the location, the more the market value can rise within three to ten years. For anyone inheriting a luxury property, the holding period therefore first means living comfort – whether for themselves or for their children – and then an all the more lucrative sale; if of course, this is what is wanted. Keeping a property in the family and passing it on to the next generation yourself is also an attractive option for many inheritors.”

b) The owner bequeaths a privately used residential property

If an owner has used a residential property themselves up until their death, in most cases no inheritance tax is due – provided the house or apartment is inherited within the immediate family, i.e., by a spouse, registered partner or children, and the beneficiaries continue to use it themselves. In principle, spouses or civil partners can take over the property tax-free, regardless of its size and market value. Children, on the other hand, are only entitled to a living space of 200 m² as a tax-free inheritance: every additional square metre is subject to inheritance tax and is therefore taxable.

“At first glance, this percentage taxation may seem like a long-term disadvantage for properties with a lot of floor space, but in practice, even a penthouse apartment or a city villa can often be bequeathed tax-free,” explains Dr Axel Schmitz. As the Managing Director at RALF SCHMITZ, he personally advises clients on choosing the right property – both for their own future plans and also with a view to possibly passing it on to future generations. “After deducting the tax-free 200 m², beneficiaries can first claim their tax-free allowances before the tax burden is calculated. In tax class I, this allowance amounts to €400,000per child according to the inheritance tax law, which often immediately covers the taxable portion. If this is not the case, it is mostly not a single apartment, but a whole house, which the owners can divide into several residential units to leave each child a tax-free share.”

However, in order to preserve the value of the investment, it is not only the owner who must proceed prudently when dividing the property among their successors. The beneficiaries themselves must also be aware of their rights and, above all, their obligations. Thus, the period until the income-tax-free resale of a private residential property can also be reduced if the owner used it themselves in the year of the sale and in the two years prior[7]. However, in the case of an inherited property, the holding period of ten years applies as part of the inheritance tax assessment. If a property that was inherited free of inheritance tax is sold before the speculation period ends, the transaction is therefore already free of income tax after a maximum of three years of own use, however, the full inheritance tax will be due retrospectively at the same time.

Pour ce qui est de l’avenir, il ne s’agit pas de le prévoir, mais de le rendre possible.

As for the future, your task is not to foresee it, but to enable it.

Antoine de Saint-Exupéry

Investing in the next generation: Why it’s worth looking towards the future when buying property

Targeted investment in real estate is one of the best ways to provide the next generation with the support it needs – whether via the living space itself or the capital tied up in it. At the same time, a broad-based real estate portfolio also offers benefactors the opportunity to prevent tensions among their heirs.

“We often see owners of sprawling properties looking to downsize. For many of them, this step marks the beginning of a new phase in their lives: the children have grown up, the house feels somehow empty, and if it cannot be divided into a sufficient number of residential units, sooner or later the property threatens to become a strain on relationships within the family,” says Dr Axel Schmitz. “If, for example, one of three heirs buys their siblings’ shares in the parental home so that they can move in themselves with their own family, the selling period must be observed. If the sale takes place within ten years of acquisition by the benefactor, two of the three siblings will lose part of their inheritance through income tax. Alternatively, the third sibling could pay them off fairly, but will have to spend an even higher percentage of their inheritance on it. In scenarios like this, there is always a loser.”

For this reason, many owners soon decide to trade in large properties for luxury apartments for their own use and invest the capital freed up by the sale in rental properties. This is a strategy that is particularly easy to implement when working with a property developer such as RALF SCHMITZ. Instead of hiring an estate agent to search for suitable apartments in various locations, buyers can simply purchase several residential units in the same building.

This not only saves time and effort, but also ensures that the capital is fairly divided among the heirs and brings them together under one roof, at least until the sales period has expired. Perhaps it’s not the house where the children grew up, but harmonious coexistence is possible and there’s plenty of room to develop individual life plans.

After all, an inherited property is worth far more than its floor area: it is also a gift to the next generation, providing support and a secure start to new phases of life.

Last updated: 2nd Quarter 2020. All details on tax law are without liability.

Bettina Schneuer

Bettina Schneuer studied law in Hamburg and then graduated from the Henri Nannen School of Journalism. She lives in Berlin and works freelance for magazines such as "Architectural Digest"

References

  1. The full text of the German Inheritance Tax and Gift Tax Act is provided by the Federal Ministry of Justice and Consumer Protection online at Gesetze im Internet (Laws Online).
  2. Cf. Section 23 of the German Income Tax Act (Einkommensteuergesetz) on Private Sale Transactions.
  3. A compact overview of the legal framework of private sales transactions is provided by Dennerlein, Birgitta: Privates Veräußerungsgeschäft (Private Sale Transactions) In: Gabler Wirtschaftslexikon. The version of the article used for this text was last revised on 15 February 2018.
  4. Cf. German Inheritance Tax and Gift Tax Act (ErbStG) Section 30 Notification of Purchase.
  5. Cf. German Inheritance Tax and Gift Tax Act (ErbStG), Section 13d Tax exemption for real estate let for residential purposes.
  6. Cf. Income Tax Act Section 23 Private Sales Transactions, Para. 1, Sentence 1, No. 1.
  7. For a list of all allowances, seeInheritance Tax and Gift Tax Act (ErbStG), Section 16 Allowances.
  8. Cf. Income Tax Act Section 23 Private Sales Transactions, Para. 1, Sentence 1, No. 1