Usufruit, Démémbrement, Nue Proprieté and the U.S. Citizen in France
One of the typical techniques used in French estate planning involves a client retaining a usufruit interest in a property while gifting a nue propriété to the next generation. In this way, the owner retains a life interest, to live in the property or to receive income from it. From a French prospective, the value of the « gift » on which French gift taxes are paid, will be dramatically lower based on the age of the donor. At the donor’s subsequent death, the usufruit interest disappears, and nothing is included in the donors estate to be taxed.
This strategy is often « pitched » to U.S. citizens by notaries and an assorted group of other advisors. However, it isn’t always as simple as it sounds. If the usufruit is a U.S. person, they follow U.S. estate tax rules as well as French tax rules. And the rules are very different for a U.S. person. Let’s start with the gift. For a U.S. person, they can be subject to U.S. income, gift and estate tax reporting.
A transfer of the nue propriété is not considered a gift for U.S. estate planning purposes. This is because the U.S. views the donor as not relinquishing the entire property but retaining a string, which is the usufruit interest. As such, the U.S. does not treat the gift as a « completed gift » but a gift with a retained interest, resulting in the full fair market value of the asset at death being includable in the U.S. persons’ estate and subject to U.S. estate taxes. Furthermore, there is no credit for the gift tax paid to France in the earlier year of transfer unless the individual also paid U.S. gift tax, which would only occur if the lifetime transfers exceeded the exemption amount. It gets worse because in France, the cost basis is not the step-up basis on death, but the value of the house at the time of transfer.
Let’s assume a house in France is worth 5 million euros. Based on the Mother’s age, she gets a 30% discount on the value of the nue propriété interest to her child, so a French gift tax is applied to only €3.5 million euros. No gift taxes were paid in the U.S. Assuming the Mother dies 10 years later, and the property is not worth 8 million euros, there will be no further French inheritance taxes. However, the full 8 million would be brought back into the Mother’s U.S. estate. She will not get a credit for the French gift taxes paid. It is an unfavorable outcome. It solves the French inheritance tax problem, but it does not solve the U.S. estate tax inclusion issue.
If the full asset had been held by the Mother at her passing, the asset would then get a full step up in basis, so a basis of €8 million. But under French law, her property would retain the basis at €5 million, so if the property was sold, there would be exposure to capital gains taxes in France (depending on how long the Mother and child held the property).
Be careful when examining French succession planning tool. They can come back to bite you.