Estate tax may not be due on foreign legacies. That was the verdict of Germany’s highest tax court – the Bundesfinanzhof (BFH) – in a judgment from November 23, 2022 (case ref.: II R 37/19).
It is generally the case that real estate passed on by inheritance is subject to estate tax. But according to this ruling from the Bundesfinanzhof, it is possible to take advantage of a legal loophole to avoid incurring the tax, explains commercial law firm MTR Legal Rechtsanwälte.
The Court held that property located in Germany can be handed down tax-free if the testator gifts it to the beneficiary as a foreign legacy. However, this is conditional on both the testator and the beneficiary residing abroad.
And that was indeed the case here. The testator, who had been living in Switzerland until her death in 2013, had left a property in Munich, Germany to her niece who was living in the US. The legacy was later executed in 2014, with the niece being recorded as the owner in the land register. The competent tax office subsequently demanded that estate tax be paid on the acquisition of the property.
The testator’s niece would go on to challenge this demand, arguing that she did not owe any estate tax because of her limited tax liability from living abroad.
Her arguments were well received by the BFH, which found that if real estate located in Germany is handed down by the testator to the beneficiary by way of a legacy and both parties are resident abroad, the latter does not incur estate tax in Germany owing to their limited tax liability. In fact, they are only required to pay estate tax for acquiring ownership of certain legally defined assets. While it is true that this includes domestic real estate, said property remains tax-exempt by way of exception if it was bequeathed to the beneficiary in the testator’s will. The BFH went on to explain that when it comes to a bequest, it is not the real estate itself but simply the claim to transfer ownership of the property that is acquired.
The situation is different if the domestic real estate passes to the foreign heir upon the death of the foreign testator in the context of intestate succession. This, according to the BFH, would entail incurring German estate tax.
Those concerned can turn to the team of inheritance and estate tax experts at MTR legal for advice.
