Real estate located in Germany can be transferred inheritance tax-free if the testator bequeaths the real estate to the beneficiary by means of a legacy and neither the testator nor the legatee has a residence or habitual abode in Germany, and both, in case of German nationality, have lived abroad for more than five years. This was held by the Federal Fiscal Court (BFH) in a ruling of 23 November 2022 (II R 37/19). The issue before the Court was whether the claim to a transfer of a co-ownership share in a domestic real estate acquired by legacy was subject to limited inheritance tax liability.
The most important in brief
The transfer of real estate located in Germany by way of a legacy may be inheritance taxfree. The prerequisites are that (1) neither the testator nor the beneficiary are resident in Germany and that (2) the legacy is subject to a legal system – the applicability of which is determined in accordance with private international law – that does not give legacies any effect in rem.
Limited Tax Liability
If the testator and/or the beneficiary are resident in Germany, the entire transfer on death is subject to inheritance tax in Germany (unlimited inheritance tax liability). If, on the other hand, neither the testator nor the beneficiary has a residence or habitual abode in Germany and both, in case of German nationality, have lived abroad for more than five years, only the transfer of certain domestic assets which are listed exhaustively in the law is subject to German inheritance tax (limited inheritance tax liability). This includes, for example, domestic real estate.
A legacy claim is generally not subject to inheritance tax in the case of limited inheritance tax liability
Until now, the BFH had not ruled on whether a legacy regarding domestic real estate can be included in the definition of domestic assets and therefore be subject to limited inheritance tax liability. By way of a legacy the testator grants a material benefit to another person without appointing him or her as heir. Under German law, this merely results in a claim under the law of obligations to the transfer of the assets included in the legacy. The transfer of the assets themselves is then made separately.
According to the BFH, the claim arising from a legacy does not fall under any of the assets enumerated exhaustively in the law which trigger limited inheritance tax liability. This would only be the case if the domestic real estate itself was transferred. A mere claim under the law of obligations to a transfer of domestic real estate is not sufficient.
An interpretation against the wording of the law would only be possible if the literal interpretation led to a result contrary to the intended meaning by the legislator. This was not the case due to the lack of comparability of the claim to a transfer and an actual transfer, because it is not sure whether the asset will actually be transferred at a later date.
The inheritance tax assessment of legacies in the case of limited inheritance tax liability applies generally. It is thus not limited to legacies concerning real estate, but extends to legacies regarding other domestic assets, for example shares in corporations.
Be careful if a foreign law of succession applies
The qualification of a legacy in inheritance tax law is governed by civil law. If the law applicable to the succession is not German law of succession but the law of another state, the qualification must be made in accordance with the foreign law. Since the legacy under foreign law may have effect in rem and may lead to a direct acquisition of the asset, the applicable law and its effects must always be considered.