Tax tip: Tax pitfalls when transferring property to children

The transfer of a property to a child can be tax-free under certain conditions, even if the property is still partially financed by a bank loan. With regard to gift tax, the loan taken over reduces the assessment basis, so that a tax-free transfer may be possible if the tax-free amount of 400,000 euros per child is applied. But what about income tax?

The Federal Fiscal Court has ruled in a judgement dated 11 March 2025 (Ref. March 2025 (case no. IX R 17/24), the Federal Fiscal Court made a groundbreaking decision in this regard. In the case in question, a father had purchased a property for around 145,000 euros in 2014 and partially financed it with debt. In 2019, he transferred the property, including the remaining loan of 115,000 euros, to his daughter. The market value of the property at this time was 210,000 euros. The father was of the opinion that this was a gratuitous transaction and that no income tax was due. He justified this by arguing that, firstly, no money had been transferred and, secondly, the loan transferred was lower than the original acquisition costs of the property. This meant that no profit was made.

The tax office took a different view and considered the transfer to be for partial consideration, which requires a division into a portion for consideration and a portion free of charge. As the father had not held the property for more than ten years, any gain from the sale would be taxable under Section 23 of the Income Tax Act. The question was whether the assumption of the liabilities by the daughter would be considered a sale within the meaning of the Income Tax Act.

The Lower Saxony Fiscal Court initially denied this, as the loan taken over was lower than the historical acquisition costs, which would have resulted in no taxable gain. However, the Federal Fiscal Court disagreed in the next instance and ruled that the assumption of debt constituted consideration and should be treated as a purchase price paid. The transfer was to be divided into a part for consideration and a part free of charge, based on the ratio of the consideration (i.e. the value of the debts assumed) to the market value of the property.

In the judgement case, the market value of the property was 210.000 euros and the liability assumed was 115,000 euros, resulting in a proportion of around 55 per cent for consideration. The taxable profit amounts to EUR 35,000, calculated from the difference between the assumed liability of EUR 115,000 and the acquisition costs of around EUR 80,000 (55 per cent of EUR 145,000) attributable to the paid portion. As there were less than ten years between the acquisition and the transfer for partial consideration, the transaction is subject to income tax.

If the property had been held for more than ten years, the transfer of the liability would not have resulted in a taxable transaction. No income tax would also have been incurred if the daughter took over the loan and the land charge in the external relationship, but was released by the father in the so-called internal relationship (judgement of the Federal Fiscal Court of 17 October 2001; III R 60/99). October 2001; III R 60/99). 

Our tip: When transferring encumbered properties, the holding period should be checked carefully. It is also advisable to clearly regulate who takes over the loans in the external and internal relationship.