Foreign Real Estate Gift: (how) does Stepped-up Basis Apply?

[toyaa0]

I would very much appreciate your input on this problem:

My mother wants to gift me the apartment that she lives in in Germany. I am a US tax person, she is not.  The transaction would have restrictions such as her lifelong usufruct of the property as well as revocation rights under certain conditions.

My concern is what would happen in the future after her passing: Would I be taxed on the gains based on sales price minus her original purchase cost or on the stepped up basis (either the date of gift or the date of her death, which is when I practically fully "receive" the gift). Both stepped-up bases are supposedly much higher than than her purchase cost.

I found the following information online: " If the beneficiary is a U.S. person, Lifetime gifts to children may result in a high U.S. capital gains tax when the donee sells the property 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 (Widerrufsrecht), the stepped-up basis may also be available in case of lifetime gifts."

Could anybody please explain the "may" to me: under which circumstances would I or would I not qualify for the stepped-up basis? How would the contract need to be framed in order to qualify?

[Mike9241]

see this article about inherited real estate. basically, rev rul 86-139 says you get a step-up in basis for real property inherited from a non-resident alien despite the fact it is not subject to US estate taxes.

https://www.hodgsonruss.com/newsroom-publications-11026.html#:~:text=Rev.%20rul.%2084-139%20%281984-... 

what you cite is what happens if mom gifts you the property before she dies.  then you get her basis and thus any gain when you sell is subject to US income taxes. 

my reading of the rev-rul and the article by the law firm would indicate that if you are gifted d any part of the property before she dies, you get absolutely no step-up. see a lawyer who is knowledgeable in foreign inheritance and gifts.  you may want to contact your state bar association to see if it can provide referrals.

[toyaa0]

Thanks so much for your answer and input, Mike! Yes, I am looking for ways / conditions that a stepped-up basis can apply to a gift, not inheritance

[TomD8]

Here's the text of the U.S. law regarding the cost basis of gifted property:

https://www.law.cornell.edu/uscode/text/26/1015

As far as I know, there is no provision in the U.S. tax code for applying a stepped-up basis to gifted property.

[tagteam]

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@toyaa0 wrote:

.....I am looking for ways / conditions that a stepped-up basis can apply to a gift, not inheritance

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There is the possibility of a retained life estate (either expressed or implied).

See https://www.law.cornell.edu/cfr/text/26/20.2036-1

However, @TomD8 is correct; there is otherwise no stepped-up basis for an inter vivos gift.

Note that the life tenant must pass away with the property in the estate for the stepped-up basis to be applicable to the remainderman.

[TomD8]

"Note that the life tenant must pass away with the property in the estate for the stepped-up basis to be applicable to the remainderman."

Correct.  Even with a life estate, there is no stepped-up basis if the property is sold or gifted prior to the life tenant's death.

[toyaa0]

Thank you @tagteam and @TomD8  ! This is very useful information.

So if I understand this correctly: What my mother is planning to do is a "transfer with retained life estate": She will have the right to live in the apartment for the rest of her life or even rent it out to her benefit alone.  There will be also certain conditions where she could claim the gift back.

However, I do not see how this apartment would still be part of her estate when she dies, as it will already be in my name at the moment of her death.

So how can the two concepts be reconciled in one contract? A retained life estate that would still be part of a "death" estate. At least by German law, I don't see how this could be done legally.

[Opus 17]

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@TomD8 wrote:

Here's the text of the U.S. law regarding the cost basis of gifted property:

https://www.law.cornell.edu/uscode/text/26/1015

As far as I know, there is no provision in the U.S. tax code for applying a stepped-up basis to gifted property.

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I agree.  Gifts do not receive a stepped up basis under US tax law. 

A life-estate may receive a stepped-up basis, but a life-estate is not quite a "gift" (gifts are generally unconditional).

You may wish to consult a tax planner. 

[Opus 17]

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@toyaa0 wrote:

Thank you @tagteam and @TomD8  ! This is very useful information.

So if I understand this correctly: What my mother is planning to do is a "transfer with retained life estate": She will have the right to live in the apartment for the rest of her life or even rent it out to her benefit alone.  There will be also certain conditions where she could claim the gift back.

However, I do not see how this apartment would still be part of her estate when she dies, as it will already be in my name at the moment of her death.

So how can the two concepts be reconciled in one contract? A retained life estate that would still be part of a "death" estate. At least by German law, I don't see how this could be done legally.

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We can't comment on German law.  There are times when US and foreign laws contradict each other, and in that case you pay tax in each country according to that country's tax laws. (For example, India allows an inflation adjustment to cost basis for capital gains.  The US does not.)

What you describe sounds like it would be viewed as a life estate under US tax law, and you would receive a stepped-up basis on your US tax return if and when you sell the property after your mother's death.  But you may wish to have the transaction reviewed by an expert.

Remember that if you are a US person (citizen, green card holder, or resident alien) you owe a US tax return that reports and pays income tax on all your world-wide income.  This is filed according to US tax law and would include capital gains on the eventual sale of the apartment.  You might or might not owe tax in Germany, and it might be calculated according to different rules.  The US will give you a credit for foreign taxes you pay on the same income, up to (but not more than) the amount of US tax on the same income.

[tagteam]

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@toyaa0 wrote:

A retained life estate that would still be part of a "death" estate.....

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A life estate is extinguished upon the death of the life tenant (at least in the U.S.); it does not become part of the estate as a result.

The remainder then passes by operation of law.

[toyaa0]

@Opus 17 @tagteam  Thank you so much for you valuable input!

So I understand now that by German law it will be a (conditional) gift, by US law a "life estate". Since for the US it is a life estate, do I have any reporting duty on it after the transaction the way I would have to report a gift?

Also, you mention that "A life-estate may receive a stepped-up basis" - what does the MAY depend on? What factors need to be considered and how do I find a professional who could give advice and is knowledgeable with both jurisdictions? Do you have any recommendations?

Many thanks again!

[tagteam]

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@toyaa0 wrote:

.....how do I find a professional who could give advice and is knowledgeable with both jurisdictions? Do you have any recommendations?

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You might try an attorney in your area that is familiar with international law or an enrolled agent.

See https://taxexperts.naea.org/listing/service/international

See also https://www.avvo.com/tax-lawyer.html

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@toyaa0 wrote:

Also, you mention that "A life-estate may receive a stepped-up basis" - what does the MAY depend on?

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You are receiving a remainder interest based upon your facts, not a life estate (which your mother is retaining). The life estate does not receive a stepped-up basis in this case, but the remainder interest will receive a stepped-up basis upon her passing (at which time her interest is extinguished and you would, typically receive the property in fee simple absolute).

The remainder would not receive a stepped-up basis, however, if the property were sold before your mother passed.

[Opus 17]

@toyaa0 

Under US tax law, the recipient of a gift is not required to report or pay tax on the gift.  If you are made the “remainderman” on your mothers property (under US law) or receive it as a conditional gift (under German law) you would have no reporting requirements in the US. You will certainly want to document the transaction for your own records.

I said you “may “receive a stepped up basis simply because I am not an attorney and I cannot know every possible variation of the transaction, especially when it includes the operation of foreign laws. Your situation sounds straightforward to me under US law, even though German law is slightly different, but I would not be representing you before the IRS if you were ever audited.   It sounds like you would need a US tax advisor (either accountant or attorney) who can look at the how the transaction would operate according to German law and apply US laws to determine how the US would view the transaction. I don’t have any specific suggestions on how to find such an expert.

[Opus 17]

@toyaa0 

Yes, just to get the terminology correct. Your mother would retain a life estate, you would have an interest in the remainder.

Under US law, at least, that means that your mother retains full rights to the property as long as she is alive and can do anything she wants including sell it, without obligation to you. If your mother did sell the property, her basis would be whatever it was, and is not affected by the conditional gift or the life-estate.  If your mother passes and you inherit the remainder, you received a stepped up basis at that time.  

[tagteam]

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@Opus 17 wrote:

Under US law, at least, that means that your mother retains full rights to the property as long as she is alive and can do anything she wants including sell it, without obligation to you. 

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Under U.S. law, @toyaa0's mother can only sell the interest she actually owns. 

If that interest is a life estate, she can only sell that life estate; she cannot sell the entire interest in the property. In this case that would be the remainder interest (which would stay intact if the life estate were sold).