I. Real estate as an object of speculation

Due to the sometimes rapid price increases on the real estate market, real estate speculation has also increased significantly in the private sector. However, anyone who resells a property within ten years of its acquisition fulfills the criteria for a taxable private disposal transaction under § 23 para. 1 sentence 1 no. 1 German Income Tax Act (Einkommensteuergesetz –EStG) (except in the case of owner-occupation for more than two years § 23 para. 1 sentence 1 no. 1 sentence 3 EStG), with the result that a profit is taxable. With a view to the progressive income tax scale and the utilization of personal allowances under gift tax, the following example is intended to demonstrate the positive effects from the BFH ruling on the basis of a modified set of facts.

II. Facts of the case

In 2014, the mother M acquired a rented residential property in Munich for EUR 688,888. She intends to transfer half of this property to each of her two children S and T by way of (anticipated) succession. In 2021, however, M receives a lucrative offer to sell the rented property for EUR 888,888, which she would like to accept. M is now faced with the decision of selling the property herself and then donating the proceeds of the sale in equal shares to her two children (direct sale with cash gift) or, in a first step, transferring half of the property to S and half to T free of charge before they then, in a second step, conclude the purchase agreement already negotiated by M with the purchaser and sell the property (gift before sale). In addition to income tax aspects, gift tax aspects must also be taken into account.

III. Taxation consequences

Due to further income, the income tax rate of M to be applied to the capital gain, if any, is 45% plus 5.5% solidarity surcharge, while the children are still studying and do not receive any income. The personal gift/inheritance tax allowance of EUR 400,000 per child has not yet been used up by gifts from the mother (within the previous ten years). The gift and income tax consequences resulting from the alternative direct sale with cash gift are as follows:
In the case of the sale of the property by the mother, the capital gain of EUR 200,000 (sale price of EUR 888,888 less the original acquisition costs of EUR 688,888) is subject to a tax rate of 45% (income tax of EUR 90,000) plus 5.5% (solidarity surcharge of EUR 4,950) for M, since she is already subject to the maximum tax rate. The subsequent gift of the cash amounts in the amount of EUR 396,969 each (net inflow from the sale from M in the amount of EUR 793,938 / 2) would in principle trigger gift tax unless – as in the present case – personal allowances in a sufficient amount of EUR 400,000 each are available. As a result, there is a total tax burden of EUR 94,950.
In the case of a gift of real estate with subsequent sale by S and T, there is initially no gift tax burden, since the assessment basis is reduced by the tax exemption for real estate rented out for residential purposes in the amount of 10% of the real estate value (assumed: EUR 888,000; of which 10% each = EUR 44,444) on the one hand, and the remaining amounts of EUR 400,000 each are within the personal allowance for each child. However, as a result of the sale, the children S and T are each taxed on half of the capital gain in the amount of EUR 100,000 (capital gain per child in the amount of EUR 444,444 less the original acquisition costs in the amount of EUR 344,444) with income tax (EUR 32,863) plus solidarity surcharge (EUR 1,807), resulting in a tax burden of EUR 34,670 per child. The advantage of this variant, however, is that the children S and T are subject to a significantly lower income tax progression level (approx. 33% compared to 45%) as a result of the 50/50 split of the capital gain. The resulting positive progression effect is reflected in a tax saving of EUR 25,610 (EUR 94,950 less 2 x EUR 34,670) compared to the direct sale with cash gift.
In the aforementioned decision, the BFH states that private sales transactions are taxable for the person who made the sale. The gratuitous transfer of the property to the children does not constitute a sale, which is why M does not generate a capital gain. In relation to the facts of the case, the ten-year period is not interrupted by the gift due to the so-called “footstep theory“ (Fußstapfentheorie), so that the sale only leads to “speculation taxation” (Spekulationsbesteuerung) at the level of the children seven years after acquisition by the mother.
The Supreme Fiscal Court also does not consider the temporal proximity between the gratuitous transfer of the property to the children, who subsequently sell the property, and the sole initiation of the contract by the mother to be an abuse of the tax system. Likewise, the more favorable taxation of the children due to the progression advantage is not classified as an abuse of the tax system, since in the opinion of the BFH, taxpayers may arrange their circumstances within the framework of what is legally permissible in such a way that the tax burden for them is as low as possible.

IV. Advice for the practice

An important finding for practitioners is that the BFH remains true to its consistent case law and does not classify the desire to save taxes as an inappropriate arrangement in itself. However, with regard to the arrangement shown, the gift tax implications must be taken into account and included in the planning. For example, the personal allowance is only granted once within ten years, which is why this structuring model can only be implemented completely free of gift tax to a limited extent – as in the case shown. If the personal allowance is exceeded, the amount of the applicable gift tax rate and its relationship to the individual income tax rate of the donor and the donee is also important in the context of the structuring considerations described above.
In the end, the present arrangement “only” exploits the progression advantage twice, which currently amounts to up to EUR 9,136.63 at a 42% top tax rate and up to EUR 17,374.99 at the 45% tax rate (so-called wealth tax, which applies to single persons with taxable income of EUR 250,000 or more).
Note on real estate values: In addition to the fact that a timely sale (in practice: within one year of the gift) can have repercussions on the basis of assessment for the gift of land, the consequential effects from the recent reform of real estate tax must be taken into account. The Supreme Expert Committee for Real Estate Values (Oberste Gutachterausschuss) in Bavaria took the changes in the law as an opportunity to ask the local expert committees to prepare the determination of the standard land values, in deviation from the previous two-year cycle, as early as the cut-off date of 1 January 2022 and not as late as 31 December 2022. Assuming that land prices have risen since the last publication (as of 31 December 2020), it may therefore be advantageous for gift tax purposes to make gifts of real estate planned for 2022 in 2021, as the standard land values last published before the transfer date are always decisive for the tax valuation.
The extent to which so-called commercial real estate trading benefits from this case law is questionable. Commercial real estate trading always exists if more than three properties are acquired and resold within five years (so-called “three-property limit” (Drei-Objekt-Grenze)). If – as in the case described – real property is transferred by way of anticipated succession, the BFH has so far taken a differentiated view as to whether these properties are to be included in the “three-object limit” for the donor or for the donee as so-called “counting objects” (Zählobjekte). Since the donor’s motives in particular must be assessed in each individual case, careful planning is also essential at this point.
The BFH has ultimately left open whether extraordinary circumstances in the course of the contract initiation or unusual elements of the contract design may not constitute an abusive design in individual cases. Consequently, precise planning is already required when the facts of the case are arranged.