To be a successful real estate player in France - to translate your desire to purchase property into successful, secure and forward-looking ownership - you must familiarize yourself with the game board. This series of articles examines the highlights of the "game board,"that include:
1) Legal steps in the purchase of French real estate 2) Title insurance 3) Role of the French Notaire 4) Resident/non-resident buyer 5) Form of ownership - outright ownership, entity ownership 6) Effect of marital regime 7) Forced heirship rules 8) French wealth tax (ISF) 9) Pre-purchase structuring of real estate holding 10) Special 3% tax on property owned by company 11) Tax considerations upon death of an ultimate owner in a chain of ownership 12) Tax and filing obligations of entities in the chain of ownership 13) Use of a trust as ultimate owner 14) Treaty concerns 15) Gifts of interests in real estate 16) Converting from personal to corporate ownership in mid-stream. 17) French inheritance tax rates 18) Taxation in home country - foreign tax credit 19) Tax considerations on rental 20) Legal considerations on rental 21) Tax considerations on sale 22) Will relating to the French real estate
7) FORCED HEIRSHIP RULES
The subject of forced heirship rules must sooner or later materialize in your discussion of French real estate. Its presence sits like a brooding cloud over the sparkling sunny fields of your dream property. Will it rain down and disturb your tranquillity or is there some way to make it go away? The answers that you will find here will probably not be totally satisfying, but you will learn that with some understanding of the problem and some advance planning, the brooding cloud doth not a rainstorm make.
What do we mean by "forced heirship"? As the term implies, it is a guarantee to certain of your heirs, particularly children, that they will receive a pre-determined share of your assets at death. The French forced heirship rules, based in the civil law, are considered "public policy", superceding any contrary provision in your will or trust. If you are a non-resident of France, the forced heirship rules will impact only on real estate located in France. If you are domiciled in France, the forced heirship rules will affect most of your global assets. (Caution to Brits: the term, domicile, as used here, does not have the same meaning as it does in the U.K.)
The forced heirship rules in a nutshell: French inheritance laws and tax laws are structured to encourage assets to remain within the immediate family. The gift and inheritance rates are skewed in favor of the immediate family: gifts and bequests to that group are taxed at the lowest rates, while gifts and bequests to others are taxed at progressively higher rates. While tax rates are a strong incentive to retaining family property within the family, the forced heirship rules are the clincher, requiring a certain portion of your property to be left to your children. Keep in mind that "children" include legally adopted children, illegitimate children as well as children of a former marriage. The share that a child is entitled to depends on the number of children you have.
-If you have one child, he or she is entitled to one-half of your estate. -If you have two children, they are entitled to one-third each. -If you have three or more children, each child is entitled to an equal portion of three-quarters of your estate.
The residual, after subtracting the forced heirship amounts, may be willed to anyone (even to one of the children, thereby allowing you to favor one child over the others). Of course, in most cases, the residual is left to the surviving spouse.
These rules are best illustrated by examples.
(1) You and your wife own French real estate jointly or in community. You have two children between you and you have a child from a prior marriage. You die. Result: As the property is owned jointly, one-half the value is already owned by your wife, so only the other half is included in your French estate, and is subject to forced heirship claims. As you have three children, each child has a right to one-quarter of your half, or 12.5%. The residual, namely, the last quarter of your half, may be left to any of your three children, to your wife, or to whomever else you please. If you leave it to your wife, she will then own 62.5% of the total (the 50% she already owned plus one-quarter of your half).
(2)You own French real estate in your own name. You and your wife have one child between you and she has two children from a former marriage. You die. Her two children have no interest in the property. Your common child has an interest in one-half, allowing you to leave the other half to your wife.
The forced heirship rules apply as well to grandchildren or great-grandchilden (assuming a child is deceased at the time of your death, leaving descendants). It also applies to your parents and grandparents, but not if any of your children are living at the time of your death.
So, what is the big to-do about forced heirship? Anglo-Saxons (Americans included) rail against the forced heirship rules, as they interfere with the freedom they are used to under the common law system. That, then, is the dark cloud. How can we make it go away, or at least soften its effect.
The SCI. For non-residents, purchase of the real property through a French real estate holding company, known as an SCI ("Société Civile d'Immobilière") will avoid the forced heirship rules completely. Technically speaking, you are considered as owning the shares of the SCI rather than the real property owned by it, and, for non-residents, company shares do not fall into the forced heirship sphere of influence. The black cloud has magically disappeared. You are free to will the property to whomever you wish. (N.B., ownership of property through an SCI does not exempt you from the French inheritance tax.) Interesting pointer: Even a French resident may decide to use an SCI to hold real estate, but for other reasons, such as easier division of the real estate later on, through gifts of shares of the SCI to children, etc. The cost of setting up an SCI is not high and will give a non-resident the peace of mind from knowing that your overall estate plan will not be disturbed by the addition of French real estate as one of your assets. While it is possible to transfer property already owned to an SCI, there are transfer taxes and notarial fees involved.
Tontine Clause. The use of a "tontine" clause in the real estate deed has the effect of postponing the interest of children until the death of the second spouse. Legally speaking, such a clause makes the survivor the sole owner of the property as if he or she owned it all from the outset. It is a legal fiction that avoids the forced heirship rules and as well as inheritance taxation at the death of the first co-owner. Use of it should be carefully considered, as it cannot thereafter be changed and, for example, if you later get divorced, the survivor of the former couple gets all!
French Will. Let's assume that you are a resident of France or, if a non-resident, for one reason or another you do not own the French real estate through an SCI. We know that your children acquire legal rights in the real estate at your death. Is that good news or bad news? Good for the kids, certainly. But not so good for your surviving spouse. Is there some way to turn bad news into good? Where there's a will, there's a way. You could leave your spouse's residual interest to her shall be in the form of a "usufruct" in the entire property. In that way, she may inhabit the property rent-free or else rent it out and enjoy the rental income, or even leave it dormant. It's hers to use as she sees fit. What she cannot do with a usufruct interest is sell the property or use it as collateral for a loan (mortgage), as the underlying title to the property belongs to the children. So, bequeathing the residual to your wife as a usufruct does not change the fact that the children own the property, but does suspend their use and enjoyment of the property during your spouse's life.
A usufruct is only one way to offer your wife the maximum use of her residual rights. A more common practice is to grant her in your will an election, exercisable at your death, to take her residual interest in one of three ways: (1) a "usufruct" interest, as explained above; (2) the entire residual interest outright, or (3) to take 25% of the property outright plus a usufruct interest in the rest. Granting her the election is useful for two reasons. First, it gives as much latitude to her as one can in France to decide, once you are gone, what is best for her; and second, it may assist in tax planning - she and the children would have more freedom to decide which of the three choices is most advantageous from an overall tax point of view - looking at the property holding over both lives. You may be thinking that the second election above is not workable in a real estate setting. For example, say you have two children, and your spouse's residual interest is therefore one-third. How can she "take" her residual interest? Good question. The answer is: (a) that she could force a sale of the property and take her one-third of the proceeds, or (b) the children can buy her out - which they would do if they wanted to keep the property, or (c) exchange their interest in other property of your estate for her remainder interest, or (d) if you were residents of France and the time of your death and had originally purchased the property through an SCI, by electing one-third outright, your spouse would wind up owning one-third of the shares outright, i.e., be an equal shareholder with the two children. (The reason "d" would not be relevant for non-residents is that, as stated above, the use of the SCI would avoid the forced heirship rules altogether!)
Change of marital status. A more sophisticated approach to delaying the interest of your children until your wife's death is to change the property arrangement governing your marriage officially to the contract of universal community property. The effect of this is the same as the tontine arrangement discussed above, but requires far more consideration and cost (as the contract must be done before a French Notaire). It is not discussed here any further except to say that for French residents it is a viable way of frustrating the forced heirship rules and should be explored.
Keep in mind that what we are referring to in this section when we speak of an interest in "your property", is the portion of the property that you owned at your death. So, if you and your spouse purchased the property jointly or if your marriage was a community property marriage, your spouse may already own one-half of the property. In that case, at your death, the "property" to which your spouse's remainder interest relates is your half. In the example above, she would already have owned one-half. If she elected #2 - to take one-third, then her total interest in the entire property would be 50% + 1/3 of the other 50% = 66.67%.
If you were a non-resident when you purchased real estate through an SCI, and became a resident later on, remaining so until your death, the forced heirship rules would apply to your global property including the SCI shares. This underscores the idea that the use of an SCI to avoid the forced heirship rules does not work for French residents. Even if the strategy would have been effective had you remained a non-resident, your later change of status would in a sense retroactively reverse that plan.
That brings up the question of who is a resident for purposes of the forced heirship rules. As we will see when we discuss French inheritance tax, longevity or brevity of presence in France might affect whether you are taxable on non-French-based assets. The same is more or less true in matters of forced heirship rules. If it is clear from the facts and circumstances that you intended to leave France within a short while, there is a chance that the authorities (i.e., the Notaire who handles your French estate) will accept that your non-French estate does not come within the purview of the forced heirship rules. But, this is indeed a "grey area" as it does indeed turn on how the facts fall out and how they are presented to the Notaire.
Remember this: Except where there is a minor involved, the only ones who can raise a claim to a forced heirship right is the person who has such right. In many if not most families (families with children of a prior marriage are usually an exception), the children will want to allow their surviving parent to do with the property as she or he sees fit, so will not try to assert their rights over the property (or may do so only for tax purposes - discussed in another section). This point is especially important to keep in mind for those who have family trusts - either inter vivos trusts (revocable living trusts) or testamentary trusts (which will come into being at your death). In America and Britain, the rules set forth in a trust agreement are inviolate. You can decide which how much and when a particular beneficiary will come into their interest in your estate. If State laws in the U.S. tend to favor and protect, any class, it is the wife. The French forced heirship rules may be the fly in the ointment of a carefully thought-out estate plan, even one that existed when you become a French resident. Despite the iron-clad terms of a trust agreement, there have been cases where children have pressed their claim under French law for their guaranteed interest and they have insisted that it be granted to them now, contrary to what the terms of the trust might provide. So, if you wish to buy French real estate and hold it in your family trust, whether or not you are a French resident, the effect of the forced heirship rules must be carefully considered.
Possible Exception to the Forced Heirship Rules. Particularly applicable to those of you who are planning to become residents of France, and to some extent even if you already are a resident, it may be possible to circumvent the forced heirship rules, certainly with respect to your non-French property. A special form of U.S.-based trust may be available to accomplish this. The concept is new and cannot be discussed in detail in this format.
Caveat and disclaimer. The forced heirship rules are complex and "fraught with peril". I have tried here to present the subject in a way that will alert you to some of the major pitfalls. However, nothing contained in this article should be construed as legal advice and you are strongly urged to seek competent professional assistance before taking any steps discussed herein.
EDITOR'S NOTE: Samuel H. Okoshken, an American, is a U.S.-educated tax lawyer, and has been practicing law in Paris since 1974. His practice is devoted to the various legal and tax problems of Americans and other foreign "expats," and to the issues that non-residents of France encounter when contemplating buying property or setting up business in France. He will be speaking at the upcoming Working and Living in France Conference here in Paris this October (http://www.adrianleeds.com/parlerparis/liveinfrance) His website is: http://www.okoshken.com