French taxation repercussions in connection with the purchase of a second home in FRANCE by a French fiscal non-resident

Foreigners who decide to purchase a second home on French territory often feel lost in a "thick fog" when tax consequences in relation to their acquisition are referred to.

And with good reason ! The heaviness of the French taxation system and superposed taxes that affect the owners are only too obvious.

Considering their status as French fiscal non-residents, some might be led to believe that the real property they are purchasing, for instance on the French Riviera, will be liable for tax in the country where they reside. That is not at all the case. In real estate matters it is the law of the real estate location that prevails. As the property is located on French territory, it is the French taxation system that applies except in rather infrequent cases where the tax agreement between FRANCE and the buyer's country of residence would provide otherwise.

Therefore it is important to be well informed about the tax agreement binding FRANCE (place where the real property is purchased) to the buyer's taxation residence country.

Tax consequences may be different depending on the agreements, in particular when is considered the opportunity to form a (French or foreign) company that will serve as a support for the purchase of real property in FRANCE.

As we already specified above, taxation governing real property acquired in FRANCE by French fiscal non-residents is complicated. To simplify its presentation, we will consider the three phases of the existence of real property : o purchase o possession o transfer and / or conveyance We hereafter will be very attentive to succinctly present the main taxes that apply to real property to be used as a second home in FRANCE.

Purchase (property completed for over 5 years)

The purchase of real property in FRANCE entails payment of transfer taxes at the rate of 4.80 % on the value of the property.

Taking into account the other costs related to the purchase of the property : mortgage costs (usual security in the event of resorting to a bank loan) notary fees and various taxes, the purchase costs (more commonly improperly referred to as notary fees) may be estimated in a range of 7.00 % of the purchase price. They are fully borne by the buyer.

Possession

When the property's taxable net value (property value minus contingent debts) is higher than € 732,000.- then its owner, French fiscal resident or non resident, will be liable for French tax on capital.

Such tax to be paid each year is calculated according to a bracket progressive scale the tax rate of which ranges from 0.55 % to 1.80 %.

Therefore a real property financed by personal monies which consequently would not be burdened with any debt and the value of which would be € 4.M - would entail payment of a Tax on Capital of € 28,784. - per annum, that is an annual cost representing more than 0.70 % of the purchase amount.

Transfer

There might be two possibilities :

a. Sale of the property

Upon transfer of real property in FRANCE and if the property is possessed in the personal name or for instance through a property investment partnership governed by French law (both possibilities cover more than 95.00 % of possession types) the possible capital gain comes under the real estate capital gain system for private individuals.

The system in particular provides for full exemption of taxation on capital gain in FRANCE if the property sold has been owned for more than 15 years.

In the event of a transfer prior to the time limit of 15 years, the capital gain made benefits from an abatement of 10.00 % per annum as of the fifth year of ownership.

The taxable net capital gain is then liable for tax according to a taxation rate varying according to the vendor's country of residence.

If the vendor is a resident in a member state of the European Union (ENGLAND or BELGIUM for instance) then the tax rate is limited to 16.00 %.

Otherwise, the tax deduction is at 33.33 %.

Special attention should be given to the tax agreement between FRANCE and the vendor's country of residence which may provide for a taxation under the transfer capital gain according to the country of residence taxation system.

In such case and subject to the texts of the tax agreement, the tax paid in FRANCE shall be deducted from the tax to be paid in the vendor's country of residence.

Besides exemption of taxation after a period of ownership of 15 years, the French taxation system offers other exemption cases (sale of main home in particular, mentioned for the record as the present article deals only with second homes).

A rather ill-known exemption case is worth mentioning : it is the first sale in FRANCE of a real property by a French fiscal non-resident, a citizen of a member state of the European Union with the proviso that he be continuously fiscally domiciled in FRANCE for at least two years at any time prior to the transfer.

b. Conveyance in the event of death

The purchase of real property to be used as second home is most often made with a view to perpetuate the property in question in the family estate.

Therefore it is most important to pay very special attention to this phase of the existence of a real property, so costly may its conveyance turn out if not prepared.

In actual fact, the tax schedule relating to French estate duty between spouses and between parents and children provides for taxation brackets which extend up to 40.00 % of the property value.

Like Tax on Capital, the taxable basis is meant after deduction of contingent debts.

As an example, devolution of a real property in FRANCE of a value of € 3,000,000.- with no debt incurred, to the spouse and two children (we suppose they all are heirs to the succession) would generate in FRANCE estate duty reaching € 700,000.- which might be a very high amount to be borne by the heirs, forcing them to sell the property (very often in bad circumstances) in order to have the liquid assets required to pay such estate duty.

Fortunately solutions do exist in order to reduce the weight of such estate duty.

It would be tempting to imagine that to incorporate a foreign company would allow to avoid any French taxation relating to natural persons since the company would constitute a "shell company" like "off-shore" companies or foreign companies without registered shares.

However the French legislator provides in such cases that the company in possession of the real property must pay an annual tax equal to 3.00 % of the marketable value of the property without possibility to deduct existing contingent debts on the property. Are not liable for the tax of 3.00 % companies with their registered office in a country or territory which concluded with FRANCE a fiscal agreement for administrative assistance and subject to disclosure of the shareholders' identities.

Making the most of the French tax system

To organize the conveyance of the French real property to the children under good legal and fiscal conditions is a very often mentioned aim.

To do so, it might be relevant when alive to make a donation of the property to the children with full ownership or bare ownership.

Actually when the donor is under 65 years old, the donation duty to be paid benefits from a 50.00 % tax abatement (30.00 % between 65 and 75 years of age).

The donation with bare ownership allows the parents to retain the usufruct (that is the use of the property or rental income as the case may be) and at the same time to reduce the taxable basis. In the event of a donation with bare ownership by parents between 51 and 60 years of age, bare ownership fiscally represents 50 % of full ownership value : the amount on which the sum of taxes to be paid will be calculated is therefore cut nearly by half.

With this view to conveyance, forming a property investment partnership which would use a bank credit to finance its purchase, may in certain cases prove appropriate.

As the company is indebted, the donation of shares with bare ownership would bear on net assets close to 0 (assets - liabilities) so allowing to convey the subsequent enhanced value of the property with exemption of estate duty.

For an owner whose main purpose is to ensure the protection of his wife in the event of death, he might, for instance, be suggested in certain situations to modify his marriage settlement so as to adopt the universal community system with a provision of entire assignment of full ownership for the benefit of the surviving spouse.

The universal community would bear only on real estate assets located in FRANCE.

Therefore, in the event of death of one of the spouses, the surviving spouse would become the full owner of the real estate assets at issue exempt from estate duty.

Finally, we could not end such brief summary without mentioning the bank loan which offers a definite fiscal interest. Actually, the bank loan taken out to finance the purchase of a real property in FRANCE constitutes a debt fiscally deductible from the property value both for calculation of Tax on Capital and of estate duty (in the event of death during the term of the loan).

So, the taxable value of a property purchased for € 3.M - and financed up to € 2,5.M through a bank loan will finally amount to € 500,000.-

Of course the succinctly outlined solutions mentioned above are not exhaustive and other systems may be developed in order to reduce the weight of the various taxations.

Conclusion

Prior to any study of the solutions to be implemented in order to diminish the fiscal repercussions of a purchase of real estate in FRANCE, it is important to make a full diagnostic of the buyer's patrimonial and fiscal situation and to be well aware of his objectives.

How can appropriate solutions be provided without knowing the buyer's fiscal status when one is aware of the importance of international taxation agreements ?

The proposed system will not be the same as regards a German citizen residing in ENGLAND and a Belgian national who lives in BELGIUM.

For instance, if forming a property investment partnership under French law to purchase a property may prove judicious because it constitutes a good means of conveyance (for someone who wishes to organize the conveyance of his property) it should be avoided as regards an English citizen residing in England from a legal as well as fiscal viewpoint.

Let's make it clear, there is no miracle solution allowing zero rate taxation.

However, a good knowledge and use of French legal and fiscal regulations may allow to reduce very significantly the weight of French taxation.

When purchasing a second home in FRANCE, it is therefore most important to wonder about the method of purchase (in cash or through a financing credit) mode of ownership (directly or through a structure to that effect) in order to reduce the French fiscal repercussions within the scope of the objectives set.

Didier HUGON
Director of real estate department SG MONACO Private Banking.