Usufruct and Usufructuary Right in Germany

Usufruct and Usufructuary Right in Germany

What is usufruct?

Usufruct is the right to use a specific property and derive income from it, despite not being the property's owner. It enables one individual to gain the economic benefits from an asset while another person retains legal ownership.

Usufruct is among the oldest instruments of asset succession planning, with roots dating back to the third century BC. Today, it remains an effective and appealing tool for asset succession planning, particularly for skillfully managing and potentially minimizing the inheritance and gift tax burden, as well as the income tax burden. Usufruct can be established over nearly any asset, including real estate, company shares, and even - a fact often overlooked - financial assets and securities.

Usufruct and Usufructuary Right in Germany | Law Firm

Reserved usufruct and beneficial interest

Usufruct essentially permits the holder of the usufructuary right (usufructuary) to “siphon off” the income from an asset they do not (or no longer) own (reserved usufruct). For instance, real estate, company shares, or even securities accounts can be transferred to children, while the income continues to flow to the parents or the original owner, who is now the usufructuary.

Conversely, income from assets can be attributed directly to the children without being taxed to the parents first. The usufructuary continues to manage the asset and, if necessary, must also maintain it. However, generally - though this can be contractually altered - the usufructuary can no longer sell or encumber the asset, as they are the owner but no longer the beneficiary.

Usufruct pros and cons

Usufruct structures have many potential applications. In German income tax law, they can be utilized to shift profits and assets or to practically incorporate children into the company. Here are two examples: Why should parents fund their child's studies from their taxed income when the child has no income of their own and would be subject to a significantly lower tax rate? The same applies to other maintenance payments to a divorced spouse.

In terms of asset succession planning, usufruct can be used to shift the taxable assets as much as possible or to decrease the taxable value of the assets - not only in the context of anticipated succession, but also in a will. For instance, parents can bequeath all their assets to their children and grant their surviving spouse unrestricted access to accounts, securities accounts, and company shares. Tax traps in the common “Berlin will” can thus be skillfully avoided.

Usufruct order in favor of anyone possible

A usufruct can be established in favor of one or multiple natural or legal entities (e.g. association or corporation).

The usufruct is non-transferable or heritable. The usufructuary's right can only be exercised by another individual. However, this is generally excluded. A usufruct terminates upon the death or renunciation of the usufructuary or - in the case of a limited usufruct right - upon the end of the term.

Contractual arrangement recommended for usufruct

The basic concept of usufruct provided by law typically does not meet our clients' needs. However, this is not a disadvantage, as there is a significant amount of contractual flexibility. If parents transfer a property to their children, they may no longer make any substantial changes to the property and may no longer sell it or use it as collateral. However, all of this can be counteracted by a contractual provision.

Canceling usufruct

After we have presented our clients with the possibilities of usufruct in Germany, the understandable question arises as to what happens if it doesn't work out as planned. Of course, the usufructuary right and the associated contracts can be structured in such a way that it is possible to return to the “original state” at any time. In the case of transferred properties, notary fees may then be incurred again. The usufructuary right is also a very secure structuring tool that can hardly be removed by the (new) owner of the asset unless corresponding rights have been contractually granted.

Attention: usufruct and right to a compulsory portion

There is one potential disadvantage that we do not wish to conceal. Depending on the structure of the usufructuary right, it is possible that the ten-year compulsory portion amortization period does not start as would be the case with “normal” gifts. Consequently, if heirs assert their right to a compulsory portion, the full value of the usufructuary right will continue to be counted as part of the deceased's assets for these purposes. However, this should be of little consequence. The right to a compulsory portion is only utilized in the event of an unfair distribution of the estate. Apart from that, there are creative ways to minimize potential risks.

Tax treatment of usufruct

The tax treatment of usufructuary rights in Germany is extremely complex and largely depends on how the usufruct is structured and on which assets a usufructuary right has been granted. Naturally, we always keep an eye on this extremely complex legal situation when considering how to organize your estate!

Usufruct variants in practice

In practice, the statutory “basic system” has given rise to countless variants for a wide variety of objectives, e.g.

  • Net usufruct (legal rule: usufructuary bears the burden of the asset)
  • Gross usufruct (owner bears the burden of the object)
  • Fractional usufruct (restriction to an ideal co-ownership share in the transferred property)
  • Quota usufruct (only pro rata usufruct)
  • Reserved usufruct (usufruct in favor of the seller)
    • Owner usufruct
    • Discretionary usufruct (usufructuary is authorized to dispose)
  • Beneficial interest (usufruct in favor of a third party)
  • Legacy usufruct (right under the law of obligations of the beneficiary to demand that the heir grants a usufructuary right)
  • Company and estate usufruct
  • Usufruct by way of security (the owner's creditor is granted security or a right of satisfaction)
  • Usufruct under the law of obligations
  • Revenue usufruct (usufructuary receives income; the owner is obliged to manage the property)

Our advisory services on usufructuary rights

  • Comprehensive concept for your unique asset succession
  • Creation of your individual (tax) optimized usufruct structure
  • Crafting appropriate contracts such as usufruct agreements and transfer agreements
  • Guidance on issues between usufructuary and owner
  • Termination of the usufructuary right

Your attorney and tax advisor for usufruct in Germany

We are more than willing to verify whether usufruct is the optimal tool for maximizing your assets for tax purposes and offer you in-depth advice. Our representatives are accessible to you at all times! The simplest way to reach us is via e-mail (info@winheller.com) or by phone (+49 69 76 75 77 85 22).

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