In more detail

1. The background

The decedent lived in Switzerland until her death. In her will, she bequeathed real estate in Munich to her niece, who lived in the United States. After the niece was registered as the owner of the property, the tax office assessed inheritance tax on the transfer of the property by way of inheritance.

2. Decision

The BFH held that if a testator living abroad bequeaths German real estate to a person also living abroad, the foreign beneficiary does not have to pay German inheritance tax. In contrast to German citizens and persons domiciled or permanently resident in Germany, foreign heirs or legatees have only limited tax liability. They will only pay inheritance tax on the acquisition of ownership of certain legally defined German situs assets, including, in particular, German real estate. However, they are exempt from inheritance tax if such real estate is bequeathed to them by way of a legacy in the testator's will rather than being appointed as heirs through statutory succession.

There is a difference in treatment for inheritance tax purposes, because in the case of a bequest in a will, the beneficiary does not acquire the property itself, but only a claim against the heir to transfer the ownership of this property. The transfer of ownership must then be made separately and requires notarization. The situation is different if foreign heirs receive German real estate in their capacity as legal successors of the deceased. In this case, ownership of the German real estate passes directly to the foreign heirs upon the death of the foreign testator. German inheritance tax will then be due.

3. Implications for succession planning

The decision provides a planning opportunity for a tax-free transfer of German real estate. All that is required is that the acquisition of German real estate is effected by means of foreign bequest/legacy that proves to be a legally valid arrangement but does not result in a direct transfer of ownership of the German real estate. In certain EU countries, e.g., Poland, a bequest results in a direct transfer of ownership rather than in a contractual claim. Therefore, the beneficiary of the bequest would also directly inherit the ownership of the German real estate. A tax-free acquisition of German real estate would therefore not be possible. It may be worthwhile to have a look at whether German inheritance law would be an option for the testamentary dispositions in order to ensure that the bequest/legacy has the intended tax consequences.

It remains to be seen whether the German legislator will change the law to align the treatment of foreign bequests with benefits received by foreign resident heirs.