Taxation of Capital Gains on Sale of Real Property situated in Germany and German-American Estate Planning

Taxation of Capital Gains on Sale of Real Property situated in Germany and German-American Estate Planning

When a U.S. citizen/resident inherits property in Germany from a non-resident alien (“NRA”) and intends to liquidate such property, there is inevitably concerns and questions regarding capital gains taxation. The article outlines the taxation in Germany and the U.S. of Capital Gains on Sale of Real Property in Germany.

Taxation in Germany

Pursuant to Article 13 of the German-American Income Tax Treaty Germany may tax gains derived by a resident of the U.S. from the alienation of immovable property referred to in Article 6 and situated in Germany.

Calculation of German Capital Gains Taxes

Germany taxes capital gains of private investors. See § 22 Nr. 2, § 23 EStG. Generally, this also includes capital gains from the sale of real estate in Germany. However, capital gains will not be taxed if the period between acquisition and selling the property exceeds ten years or in the year of the sale and the 2 preceding years, if the property was used as a home by the seller.  See § 23 (1) 1. EStG. If the owner dies within the 10-year period, it does not restart but instead is calculated from the time when the decedent acquired the property.  The taxable capital gain is calculated by deducting from the sales price the acquisition costs (e.g.  purchase price + purchase costs) and the selling costs. The acquisition costs will not be indexed. As a result, inflation-related rises in the property value will be taxed in Germany. In contrast to U.S. tax laws, there is no stepped-up-basis available for inherited property under German tax law. The capital gain will be taxed in Germany at the regular progressive tax rate.

Taxation of Capital Gains on Sale of Real Property situated in Germany by the U.S.

Even though Germany may tax gains derived by a resident of the U.S. from the alienation of immovable property situated in Germany, this does not prevent the U.S. from taxing U.S. citizen/residents for such of such capital gains. See Art. 1 para 4. (a)  of the German-American Income Tax Treaty.

Calculation of U.S. Capital Gains Taxes

Just like in purely domestic cases, capital gains on sale of real property situated in Germany are typically calculated by subtracting the sale price from the purchase price less any depreciation. When an individual inherits a property (e.g. it is distributed to the beneficiary and not sold by the Estate) in the U.S. the individual receives a stepped-up basis. A stepped-up basis increases the beneficiary’s basis in the property to the fair market value as of the date of death. (IRC §1014).

Example: A U.S. resident, inherits from his mother a house, which was bought for $50,000 in 1970 and has a date of death market value of $1.5 million. The U.S. resident would have a stepped-up basis of $1.5 million and will only be taxed on the difference between the $1.5 million and the sales price.

When real property is sold in Germany an issue arises as to whether the real property receives a stepped-up basis thereby limiting the gains for the U.S. citizen/permanent resident beneficiary. Treas. Reg. § 1.1014-2(b)(2) provides that section 1014(b)(9) property does not include property that is not includible in the value of a decedent’s gross estate, such as property not situated in the United States acquired from a nonresident who is not a citizen of the United States. However, pursuant to Rev. Rul. 84-139, 1984-2 C.B. 168, IRC § 1014(a) is applicable and the U.S. citizen/permanent resident’s basis in the property will be the fair market value as of the date of death.

Double taxation is avoided by offsetting the German tax (if any) against the U.S. tax (e.g. by filing form 1116). However, as Germany does not tax capital gains if the property was held 10 years, there is often no German tax that can be offset.

Capital Gains Taxes and German-American Estate Planning

German estate planners generally recommend to make lifetime gifts to children as the tax-free amount (EUR 400,000) “renews” every 10 years (gifts within 10 years are aggregated under § 14 of the German Inheritance and Gift Tax Act). However, if the beneficiary is a U.S. person, this may result in a high U.S. capital gains tax when the donee sells the property (what he often does if he lives permanently in the U.S.) as he may not qualify for the stepped-up basis. However, by using German estate planning instruments, e.g. a usufruct (Nießbrauch), a habitation right (Wohnrecht) or a revocation right, the stepped-up basis may also be available in case of lifetime gifts.

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