I. Introduction

A gratuitous acquisition upon death (inheritance, legacy or right to reserved portion) as well as during lifetime (gift) is subject to inheritance or gift tax. However, under section 13 the German Inheritance and Gift Tax Act (ErbStG) schedules several possibilities for tax exemption. Subsequently, the gratuitous transfer of so-called family homes is under certain prerequisites exempt from tax (section 13 para. 1 no. 4a-c ErbStG). In its ruling of 5 April 2018, the Munich Finance Court decided some controversial issues. In the ruling, the focus is placed on the question, whether the tax exemption can also have an effect on an undeveloped plot of land that is in terms of land law register independent and adjoins a family home.

II. Tax exemption for family homes

Pursuant to section 13 para. 1 no. 4a-c ErbStG, the transfer of a so-called family home by way of gift or acquisition upon death to a spouse or life partner as well as by means of acquisition upon death to children or stepchildren is exempt from tax.
Family homes are defined by law as a developed property located in Germany or in the EU/EEA area, provided that

a) the gift-giver uses an apartment together with his spouse / life partner for own residential purposes, or

b) the testator uses an apartment for own residential purposes until succession (or is prevented from self-use for overriding reasons) and that the apartment is intended for immediate use for own residential purposes by the purchaser. In addition, the purchaser must actually use the apartment for own residential purposes for 10 years after acquisition (or be prevented from self-use for overriding reasons). In case of an acquisition upon death by (step-)children the tax exemption only applies to the extent that the living space does not exceed 200 m².

The use for own residential purposes requires that the center of the family life is located in the apartment. Therefore, second or vacation homes in particular are not favored.

III. Decision of the Munich Finance Court on the exemption from inheritance tax for an undeveloped, in terms of land register law independent plot of land, which adjoins the family home

Subject of the decision of the FG Munich was the question, how it affects the tax exemption, if adjusting to the developed and for own residential purposes used property exists a second, in terms of register law independent plot of land, which is consistently used and transferred together with the developed property.

1. Facts of the case

The judgment was based on the following facts:
The testator was inherited by her daughter (claimant) due to legal succession. The estate included a property with a condominium in which the testator had lived until her death. Adjacent to this property was another undeveloped plot of land in the estate of the testator, which was used by her as a garden. In terms of register law, these two properties were independent. The claimant continued to use the condominium after the death of the testator for own residential purposes and the adjacent property as garden.
The tax office of the tax assessment applied the tax concession for family homes only to the land occupied by the condominium, but not to the adjacent land used as a garden. The heiress’ lawsuit was directed against this after the objection was rejected.
The claimant argued that the two plots of land were used jointly and that, according to the prevailing opinion, they were in a uniform usage and functional context. The two properties therefore constitute a single economic unit within the meaning of section 2 of the German Valuation Act (BewG), to which the overall tax concession for family homes under section 13 para. 1 no. 4c ErbStG applies.

2. Decision and reasons of the Munich Finance Court

The Munich Finance Court ruled that the tax office was right to apply the tax exemption only to the land register property on which the family home is located. The adjoining, undeveloped, in terms of land register law independent property, however, is not tax exempt. The Court rejected the existence of an economic unit within the meaning of section 2 BewG and even went so far as to state that the tax exemption would not apply to the undeveloped land even if the two properties were economically united.
In the opinion of the Munich Finance Court, tax relief regulations are to be interpreted restrictively in principle, taking into account the purpose pursued with them and their exceptional nature. Already according to the wording of section 13 para. 1 no. 4c ErbStG, only the property on which the family home is located is tax-exempt. A factual extension beyond the wording is denied by the jurisdiction. Adjoining, undeveloped, independent plots of land are therefore not tax-exempt even if they form an economic unit with the developed land. The claimant filed a complaint of non-admission against the decision of the Munich Finance Court. The decision of the BFH is still pending.
A similar decision was made by the Düsseldorf Finance Court in its ruling of 16 May 2018 (file no.: 4 K 1063/17 Erb). The wording of section 13 para. 1 no. 4c ErbStG does not address the question of economic unity. The decision as to the extent of the tax exemption must therefore be assessed completely independently of the existence of an economic unit. Following the wording of the exemption regulation it depends alone on whether a plot developed with a family home is present. The term “plot” is to be understood as a term under civil law and therefore refers to the area of land that is registered on a separate number in the inventory of a land register folio.

3. Assessment and recommendation

The key problem in the legal dispute described is the question of the relationship between the exemption provision in section 13 para. 1 no. 4a-c ErbStG and the valuation provision in section 2 BewG. Section 2 BewG stipulates that in the case of public-law dues (including gift and inheritance tax) the valuation of assets must be based on their economic unit as a whole.
Both the Munich Finance Court and the Düsseldorf Finance Court have ruled that the valuation rules (BewG) do not apply as long as the wording of the tax exemption is not applicable. Thus, if an adjoining plot of land is undeveloped, even by “anticipating” the valuation regulations and the affirmation of an economic unit, it cannot be included in the exemption provision of section 13 para. 1 no. 4a-c ErbStG.
The Federal Court of Finance (BFH) has already commented several times that the tax exemption for family homes is only constitutionally justified if it is interpreted strictly. It is therefore to be assumed that the BFH will follow the line of the Finance Courts.
From a tax law perspective, it would therefore be advisable for the owner of several adjacent plots of land, who wants to give the land plots, not all of which are developed with a family home, to the same person, to unite the plots of land in the land register before making the grant. For an association, it should be noted that the adjoining plots of land should not be encumbered with different mortgages or real charges, or with the same mortgages or real charges, but in different ranking order, according to section 5 para. 1 German Land Register Ordinance (GBO). In addition, the advantages and disadvantages of an association lying outside tax law must be taken into account. Whether an association is actually financially advantageous must be examined on a case-by-case basis and in particular with regard to any tax allowances.

IV. Conclusion

In the case of succession planning as well as in the case of gifts (at least until the judgement of the BFH), due to the restrictive interpretation of the Finance Courts as well as the previous BFH case law on the subject of tax exemption regulations for family homes, it must be assumed that undeveloped plots of land are not tax-exempt even if there is an economic unit with the family home. In individual cases it should be examined whether it is possible to merge plots of land.