Property is a very good way of transferring assets to the next generation at an early stage. If the parents reserve the usufruct, they transfer the assets but retain the source of income and continue to receive the income from the property. The transfer of real estate subject to usufruct is a popular arrangement in the context of anticipated succession for many reasons.
Why does the transfer of property during one's lifetime under reservation of usufruct allow better utilisation of gift tax allowances?
If assets are transferred by way of succession, the heirs can utilise inheritance tax allowances depending on the degree of relationship. Naturally, however, tax allowances can only be utilised once in the event of inheritance. However, gift tax and inheritance tax are largely identical and interlinked. This means that the allowances can be utilised again every 10 years. The gift and inheritance tax allowances can therefore be utilised several times by transferring property to the next generation during one's lifetime.
However, when property is transferred subject to usufruct, the parents do not completely relinquish their assets. The children cannot „do what they want“ with the property transferred to them. The parents are still entitled to the use of the property and the further use of the property can still be determined by the parents by structuring the transfer agreement, e.g. by agreeing prohibitions on sale and retransfer rights.
Another advantage of the arrangement is that the value of the gift to the children can be significantly reduced by reserving the usufruct. The children do not receive the entire value of the property, but the value of the property minus the value of the usufruct. In this way, properties whose value is significantly higher than the gift tax allowance can be transferred to the next generation free of gift tax. If the usufruct is subsequently cancelled due to the death of the beneficiaries, this does not constitute a transaction relevant for gift or inheritance tax purposes.
What is the difference between a conditional usufruct and a beneficial usufruct?
In the context of anticipated succession, the reserved usufruct is important first of all. When real estate is transferred to the next generation or to those persons who will later become heirs, ownership of the property is transferred, but the transferor retains the usufruct. In this case, the transferor and the usufructuary are identical. If, on the other hand, the right of use is granted to a third party, this is a beneficial usufruct. This distinction is of decisive importance for the tax assessment.
However, usufruct can also play a role in the context of anticipated succession. For example, if a property is owned solely by one spouse and this ownership is to be transferred to the next generation during their lifetime, the transferor initially reserves the usufruct. It is then often additionally agreed that the surviving spouse will be granted usufruct after the death of the first deceased. Only when the surviving spouse also dies does the next generation enjoy unencumbered ownership. As the surviving spouse in this case was not previously the owner of the property, the granting of usufruct in favour of the surviving spouse is a beneficial usufruct on the part of the other spouse.
Who is entitled to the rental income when a usufruct is granted?
If usufruct is reserved when the property is transferred, the usufructuary is entitled to the following rights § 1030 BGB the income from the property. The usufructuary remains the landlord of the property. In this respect, despite the change of ownership, there is no change of landlord in the tenancy relationship with the tenants. In this respect, the provision of Section 566 of the German Civil Code (BGB), according to which the purchaser assumes the rights and obligations arising from the tenancy in place of the landlord for the duration of his ownership, is generally irrelevant in the case of the reservation of usufruct.
Which costs in connection with the property must be borne by the owner and which by the usufructuary?
The usufructuary is obliged to ensure the maintenance of the property and to bear public and private charges relating to the property for the duration of the usufruct (§§ 1041, 1045, 1047 BGB). Due to the legal regulation, the usufructuary only has to pay for the usual expenses.
Extraordinary repairs and renovations (such as major maintenance work), on the other hand, must be carried out by the owner. This is usually regulated differently as part of the anticipated inheritance regulation and the usufructuary is also contractually obliged to bear the extraordinary expenses. The background to this is that the children will only be able to use the property economically themselves after the death of their parents and should therefore not be burdened economically beforehand.
How is the transfer of real estate subject to a usufruct to be treated for income tax purposes?
The income tax consequences of usufruct have been largely clarified („usufruct decree", BMF of 30 September 2013, BStBl. I p. 1184). The usufructuary who receives the income is taxed on this as income from letting and leasing.
In the case of reserved usufruct, he can continue to claim the depreciation for tax purposes, as he has borne the acquisition costs of the property himself. In the case of a grant usufruct, however, it is not possible to deduct depreciation. This is because the usufructuary did not bear the acquisition costs and the owner does not earn any income.
If the usufructuary bears the expenses in connection with the property due to a legal or contractual obligation, he is entitled to deduct income-related expenses. Against this background, it is crucial that the usufruct agreement also imposes an obligation on the usufructuary to bear the extraordinary expenses, as the usufructuary would not have to bear them under the statutory provisions. If there is no contractual agreement and the usufructuary nevertheless bears these expenses, this constitutes a gift to the property owner. Neither the owner nor the usufructuary can claim the costs for tax purposes.
What is the value of the usufruct?
The usufruct is recognised at the capital value (§§ 13 until 16 BewG), which is calculated by multiplying the average annual value by a multiplier that depends on the duration of the usufruct.
In the case of a lifelong usufruct, the age of the usufructuary is decisive (§ 14 BewG). The multipliers are published annually by the tax authorities on the basis of the mortality table.
The younger the usufructuary, the higher the multiplier and the higher the value of the usufruct. With higher assets, it can therefore make sense to start transferring assets to the next generation earlier, because if property is transferred subject to usufruct, the younger the transferring person who reserves the usufruct, the lower the value of the gift.
Can the usufruct also be granted to the other spouse who does not own the property?
It is often the parents' wish to receive the rental income until the last of them passes away. If only one spouse owns the property, there is usually a desire to ensure that the other spouse continues to receive the rental income after their death.
The right of use of the other spouse can be organised in different ways. For example, the spouses can reserve a joint usufruct from the outset or the usufruct of the other spouse only takes effect upon the death of the donor. The variants have different tax consequences.
In the case of total usufruct, the capital value of the usufruct is calculated using the higher multiplier of the two spouses, which can be advantageous if, for example, the non-gifting spouse has a higher multiplier than the donor, as this results in a higher usufruct value as a deduction item. If only one spouse owned the property, the other spouse receives a beneficial interest. The usufruct is subject to gift tax (this can be taxed at the annual value upon application), § Section 23 ErbStG). This option is disadvantageous in terms of income tax, as half of the depreciation can no longer be claimed due to the usufruct.
In the case of successive entitlement of the spouses, only the usufruct of the donor is initially valued according to his or her age. The other spouse only receives a gift tax-relevant usufruct (subject to a condition precedent) at the time of the first spouse's death. In terms of income tax, this variant is preferable to the entire usufruct, as the depreciation for the property can still be utilised in full until the death of the first spouse.
In practice, it should be noted in this case that the original gift tax assessment can be retroactively corrected at the time of the death of the first usufructuary and the usufruct of the second spouse can be taken into account. However, the change is only possible upon application. This must be submitted by the end of the year following the death of the first spouse (§ Section 6 (2) in conjunction with. § Section 5 (2) BewG). As a usufruct can run for many years until the second spouse becomes entitled to it, appropriate precautions must be taken to ensure that this is not forgotten. In particular, the documents relating to the gift should be kept.
Does it make sense to transfer real estate subject to usufruct even with debt financing?
The reservation of usufruct is also of interest with regard to any loan obligations that may still exist. If parents wish to transfer real estate to their children by way of anticipated succession and the parents still have loan obligations in connection with the acquisition of the property or in connection with investments in the property, the children should generally not be burdened with the loan obligations. If the property is transferred to the next generation as a gift without reservation of usufruct, the parents may then be faced with the problem that they would lack the necessary liquidity to fulfil the loan obligations or at least fear this. In addition, they may then no longer be able to claim the interest on the loan for tax purposes, as they will no longer have any rental income from the property if ownership is transferred unconditionally. The reservation of usufruct therefore ensures, on the one hand, that the parents continue to generate sufficient income from the rental income to enable them to service the debt and, on the other hand, that they can continue to claim the financing interest as income-related expenses for tax purposes.
In the case of third-party financing, however, it should be clarified whether the debts should be transferred to the property owner or to the heirs in the event of the donor's death. The testamentary disposition should therefore be coordinated with the testamentary dispositions of the transferor. If the assumption of the debts by the donee is already agreed when the property is transferred, the parents, who continue to generate the rental income due to the reservation of usufruct or may continue to use the property themselves, can release the children as the new owners internally from the loan charges (interest and amortisation) for the duration of the usufruct. However, this has the disadvantage that, according to recent case law, the annual value for calculating the capital value of the usufruct must be reduced by the interest expenses, which can significantly reduce the capital value of the usufruct (BFH of 28 May 2019, BFH/NV 2020, 146). It may therefore be necessary to examine whether the transfer of the remaining loan to the property owner in the event of the donor's death cannot be regulated in another way, in particular by testamentary dispositions. This depends on the individual situation of the family and the existing assets.
Is land transfer tax payable on the transfer of real estate subject to usufruct?
From a real estate transfer tax perspective, the usufruct - unlike for income tax and gift tax purposes - is regarded as consideration. It is therefore not a transfer of land free of charge for the purposes of real estate transfer tax, meaning that the real estate transfer tax exemption for transfers of land free of charge under section 3 no. 2 GrEStG does not apply. By way of anticipated succession, however, property is usually transferred to the next generation, i.e. from parents to children. Transfers of real estate in the direct line are also exempt from real estate transfer tax (§ 3 no. 6 GrEStG), so that in this constellation the remunerated nature of the usufruct does not have a negative effect.
The exact structure of the transfer subject to usufruct as a means of organising anticipated succession is very complex. The agreement must be planned in context. The effects on the right to a compulsory portion must be included in the considerations, as must tax aspects. Coordination with testamentary dispositions upon death (will, inheritance contract) is urgently required. It is highly recommended that succession planning be accompanied by a specialised lawyer for inheritance law.
If you have any further questions, please contact the specialist law firm for inheritance law Dr Michael Gottschalk.