Introduction: tax treatment of individuals, owners of significant real estate assets
At issue here is the tax treatment of individuals who are the owners of significant real estate assets and who are acting as professional investors, whereby:
- their main activity is usually management, and
- rents are their main source of income.
These people are a special "target" of taxation at a variety of levels:
- First as regards income tax (IT): taxation is particularly high, with such income subject to:
- - IT on a progressive scale (maximum 45%),
- - social security charges (general social contribution (CSG), social debt reimbursement tax (CRDS) & social levies) at 17.2% and
- - possibly, the contribution levied on high incomes (3% and 4%):
- ð i.e. an overall rate of 63/65%, and
- ð the method of calculating taxable income is particularly harsh as it does not permit deduction for depreciation of assets nor of the debts used to finance them (except for the BIC scheme covering furnished rentals – see below).
- As a result, taxable income is more or less the net revenues collected (before any debt repayments) minus costs and certain works (only this item can significantly reduce the tax, especially if the assets are to be used for accommodation).
- Then there is real property wealth tax (IFI, that replaces the former ISF): real estate assets fall within the taxable base and cannot under any circumstances be regarded as an exempted business asset, with the sole exception of the situation where such assets are assigned not for rentals but rather to the owner’s commercial, industrial, craft-related, agricultural or freelance professional activities.
These assets generally have a very high value in light of the income they produce and real property wealth tax is often due at its maximum rate of 1.5%.
However, this rate was determined on creation of the wealth tax in the 1980's at a time when the return on capital was some 10% or more. Today the net return on real estate investments lies more between 2% and 6%, depending on the asset category.
Thus, for a building worth €10 M (no borrowing) and a net return of 3% (typically a residential building), i.e. net rents of €300 K income tax at the marginal rate will be around 60% or €180 K. To this is added real property wealth tax at 1.5% or €150 K thus producing a negative rate of return.
Real property wealth tax is capped to ensure the overall taxation itself is capped at 75% of income: here it would be limited to €45 K i.e. overall taxation of €225 K (€300 K x 75%) and disposable income of €75 K for a building worth €10 M to produce a post-tax rate of return of 0.75%.
Often, in real estate, investors make use of debt to finance themselves. In this case, it is a matter of certainty that the after-tax income will not cover the debt and therefore, in terms of cash flow, the operation simply becomes unfeasible.
One idea that quickly comes to mind is that, in the light of the income tax burden, perhaps it is better to have no income?
To do this, the most obvious solution is to hold real estate via companies subject to CT, which means:
- rental income is taxed at corporation tax rates, i.e. at 28% (soon 25% - instead of 63-65%) on a tax base reduced by depreciation;
- only the cash flow is received personally as dividends, free of debt repayments, which limits personal taxation to such amounts.
An alternative or complementary option is split ownership: this has several tax advantages, namely:
- the bare owner is normally not subject to real property wealth tax on the value of assets held in bare ownership, and
- as no income is received (it is allocated to the usufructuary), there is no income tax to pay;
- ð while both the capital value of the asset and any growth are retained, as the owner aims to become the full owner in the long term.
These schemes are however complex and the possible options were limited by law in 2012.
In this rather gloomy tax landscape there is nonetheless one glimmer of light: the taxation of capital gains on real estate for individuals, for which the regime remains attractive.
On the one hand, the overall rate of taxation (between 34.5% and 44.5%), while higher than previously, is lower than that applicable to rental income; on the other, the tax regime governing capital gains provides allowances according to the length of time that assets are held, with taxation limited to social security charges after a period of 22 years (17.2%) and total exemption after 30 years. Finally, as regards asset transfers (gift ou by death), real estate enjoys no benefits (except in very specific cases, such as historic monuments that are open to the public), in contrast to companies where the policy is that keeping assets in the family should be supported by the State (the “Dutreil” pact). The maximum rate for direct transfers is 45%; yet here too real estate may not finance its own transfer, even by resorting to bank financing.
Split ownership may also be effective here, as an allowance permits the tax base to be reduced to the bare ownership (the aim of the transfer). The transfer of usufruct on the death of the usufructuary is not taxable: however, even with this reduction, the tax due is still very high.
In conclusion, investing privately in significant real estate assets is penalised in tax terms as compared to other economic activities. This is the result of political choices that have never been challenged, regardless of which political party holds power – perhaps because buildings can hardly relocate.
For those concerned, tax knowledge is therefore almost as important as a good knowledge of real estate matters in order to successfully create, maintain and grow their assets in France.
We present here the main tax rules applicable to privately owned real estate assets.