Capital Gains and Inheritance Taxes
Most people who buy property in Spain do so knowing the tax implications of their purchase, namely that they will have purchase taxes (see HERE) to pay and subsequent annual income tax returns to submit, and, when they sell, Capital Gains Tax to pay. Few people, however, know or are fully aware of the potentially hefty inheritance tax implications of their purchase, and it is something they need to consider because one way or another they are likely to end up bequeathing a sizeable tax bill to their heirs along with the property.
CGT is a complicated calculation, with tax levels and reductions determined in large part by the date of purchase and sale, and deductions allowed for certain validated and demonstrable expenditures and improvements, but assume 21% on any taxable profit if a non-resident; residents pay somewhat more, with the rate graded up to 27% depending on the size of the gain. For any property bought in the second half of 2012 – and only then – both residents and non-residents will have a 50% reduction in any CGT due; this was a fiscal incentive measure passed by Madrid with the intention of stimulating the property market (see HERE).
Fiscal residents are granted reinvestment relief if they buy another property with the proceeds of a sale, provided that the property sold was their main home in which they had lived for at least three years prior to selling, and provided that the new property is purchased within two years of the sale of the former. This reinvestment relief is calculated according to how much of the sale proceeds are spent on the new property: if the purchase price of the new property exceeds the sale price of the old one, the gain is completely exempt from CGT. For those who are downsizing, say, and spend half of the sale proceeds on a new property, then that half is all that’s exempt. If there is a mortgage to be paid off with the proceeds, the calculation is based on whatever is left over as capital after the mortgage is cleared. To be entitled to this relief, the capital gain must be declared at the time of sale, together with the intention to reinvest. Fiscal residents over 65 who are selling a main home in which they’ve lived for more than three years are exempt from CGT without the requirement to reinvest.
The rules are different, however, for non-residents. When a non-resident sells a property, CGT is not the main immediate issue because non-residents are required to leave a 3% retention at the point of signing in lieu of final settlement of any CGT due. This 3% non-resident retention is payable at notary and is deducted off the whole sale price. It can be recovered, but requires an application to the tax authorities, and of course, requires also that all tax affairs are up to date, including the CGT against which the retention was made – in other words you pay the CGT on top of the 3% before claiming the retention back. These factors are why so many sellers just leave the 3% retention and never try to claim it back. If you wish to do so, you will need to submit an application, and for this you will need the original seller’s copy of the tax form paying the retention. This receipt is the seller’s property by right and something that s/he should have in any case, whether or not the retention is being reclaimed.
The big problem for most property owners here is inheritance tax (also imposed according to the same calculations on gifts from the living), and it is, it seems to me, the great unmentionable. In the vast majority of British Wills, spouses are the designated heirs, and tax exempt. In Spain, however, this is not the case, and the resulting tax bill can come as a complete shock to a bereaved husband or wife. In Spain, it is blood relationships, not marital, that are given preferential fiscal treatment, and as a rough guide, ISD (Impuesto sobre Sucesiones y Donaciones) on an inheritance could amount, in some cases, to up to 34% of the inherited half, therefore up to 17% or so of the property’s value.
Note that the inheritance tax rate is applied specifically to what is inherited, and in the case of the death of a husband or wife, the surviving partner inherits 50%. The tax is calculated on this half of the property value, and is banded. For most people the rate would be around 15-20%, which is applied to an inheritance of between €72,000 and €120,000. So, if you were to have an apartment of 200,000, then 100,000 is what is left to the surviving spouse. The taxable amount has a threshold of €15,000 so we deduct that off the €100,000, leaving €85,000 liable to tax. The rate would be 16.15% for that figure, and results in a tax calculation of €14,000. (I’m not an accountant, and these figures are rounded off for ease of example, so this is just intended to give a rough idea).
To this tax calculation is applied a “multiplier”, and this varies depending on the relationship between the deceased and heir. For bequests between husbands, wives and children, the multiplier is 1 to 1.2 depending on the amount of the inheritance, so the tax as calculated above would end up being €14,000 to €16,800. For more more distant relationships, the multiplier is 2 to 2.4.
Recently, the Canarian Autonomous Region came into line with other parts of Spain, and granted tax residents a 99.9% reduction in the tax rate for inheritance between close relatives (parents, children, spouses and family partners). The reduction required the testator to have been fiscally resident in the Canary Islands for at least five years, and the heir for one year, for annual tax returns to have been submitted, and resident tax status proven by a fiscal residence certificate from the Hacienda. Moreover, after inheritance, the heir was required to remain fiscally resident in the Canaries and not sell the property for a further 5 years. As of April 2012, however, this reduction was abolished – see HERE.
As the old saying has it, the only things certain in life are death and taxes, and in the case of ISD for non-residents or any residents who have been beneath the fiscal radar, the two come together. A further potential problem arises for estates valued in the UK at more than £325,000 because there is currently no dual taxation treaty on inheritance tax between Spain and the UK. Thus for UK domiciled individuals, which is what the vast majority of us are even if fiscally resident in the Canaries, British IHT might be payable in addition to ISD, though inheritance tax paid in Spain can be offset against the British liability, despite the lack of a dual taxation treaty.
There is a range of solutions available for the payment or legal avoidance of ISD/IHT, whether a straight life insurance policy to provide a lump sum to pay the tax, or trust funds, or gifting the property into an English company (though see THIS from belegal.com, which says “using a UK company incorporated purposely is not a real, valid or legitimate vehicle to circumvent the obligation to pay Inheritance Tax in Spain”). The most important thing is to seek advice from a range of suitably experienced professional tax advisers both in the UK and Spain. Your own gestor in Spain and accountant in the UK will also have valuable ideas to contribute. Remember, though, that everyone will almost certainly have an angle, or an interest in getting your business. Make sure that the advice you get comes from as independent a source as possible, and that your final decision is in the best interests of yourselves and your heirs.