About a year ago, we talked about using real estate purchases to lower inheritance and gift taxes. Obviously, people who are able to take advantage of these schemes are already well off — the average person doesn’t have to worry about paying inheritance taxes when his or her parents die because for most people there aren’t enough assets involved.
But in the past few years it has emerged that quite a few people of means have found ways of passing on large inheritances without paying any taxes at all, sometimes even before they die. The methods seem to be legal, but last year the National Tax Agency realized how much money it was losing and started cracking down on people who used these methods. According to an article that appeared in the Asahi Shimbun in November, the agency has ordered local tax bureaus nationwide to investigate transactions related to so-called tower condominiums, because the purchases of such units are often used to hide legacies.
The secret to the scheme has to do with the assessment of assets, which is carried out by tax officials to determine the value of a person’s property for inheritance and gift tax purposes. When the property is a condominium, the assessment is in two parts: one for land, and the other for the actual unit. The land assessment will likely be small, since the actual land value is assessed and then divided among all the units in the building, so the more units there are, the smaller the value. As for the value of the unit itself, the differences from one apartment to another in the same building are based on floor area. That’s all. A 70-square-meter unit on a higher floor will have the same assessed value as a 70-square-meter unit on a lower floor.
What this means is that the assessed value is often very different from the market value, because units on higher floors are invariably more expensive than those on lower floors. What people are doing is investing their money in units on higher floors in tower condominiums, and when the owner passes the unit on to his or her heirs, the property is assessed at a certain value and the heir pays the appropriate tax. Later, however, the heir sells the property for a much higher price than that for which the unit was assessed by the tax agency. The Asahi did a survey of 343 inherited tower condos that had later been sold and found that, on average, the units sold for three times the assessed tax value.
But there are other, even more lucrative methods. In a different article, the Asahi explained how a business owner in his 60s living in the Kansai area once told his accountant that he planned to sell his company for ¥1 billion in cash. He wanted to give ¥600 million of this amount to his son, but the gift taxes on that figure would be at least ¥300 million. In order to avoid this tax, the accountant recommended he buy a tower condo.
First, the businessman established a company with the ¥600 million as capital and then, through the company, borrowed ¥400 million from a bank. With this ¥1 billion, the company bought five condominiums in “good locations” in Tokyo. Then he gave his son all the stock in the company as a gift. According to the law, there is no tax on gifts of stock. The son thus became the owner of a company that owned five condominiums with a market value of at least ¥1 billion. Moreover, the asset value of the properties for tax purposes was only ¥200 million, and since the company had a debt of ¥400 million due to the bank loan, he didn’t have to pay any capital gains taxes when, later, he sold the properties for more than ¥1 billion. Then he repaid the ¥400 million loan plus whatever interest it had accumulated, and walked away with the¥600 million his father had originally intended to give him, tax free.
The fact that the media has been covering this phenomenon openly caught the attention of the National Tax Agency, which prompted the crackdown. Sankei Shimbun’s online business publication reported last June on a book written by a former tax official about how the agency is now looking more closely at tower condo sales to see if they’re being used as tax dodges.
One of the anecdotes in the book is about “Mr. K,” a man who bought a tower condo unit on a high floor for ¥300 million. However, the assessment of the unit for inheritance tax purposes was only ¥50 million. Two months after the purchase, Mr. K suddenly died. His wife inherited the condo, and four months later she submitted papers to the tax agency. In addition to the ¥50 million condo, Mr. K’s other assets amounted to ¥30 million. The tax exemption for a spousal heir is ¥160 million, so since the total value of the inherited assets was only ¥80 million, the widow paid no taxes. However, several months later, the wife sold the condo for more than ¥300 million, paying only ¥10 million in fees and other taxes.
The tax agency found out about the sale and visited the widow, saying she had to refile her inheritance tax documents with the value of the condo reported at ¥300 million, not ¥50 million. In the end, she was forced to pay ¥30 million in inheritance taxes plus ¥4.5 million in penalties. The family sued the government, saying they had broken no laws, but the suit was rejected, first by an arbitrator and later by a judge.
The point seems to be that while present statutes do not outlaw such practices, the tax agency will nevertheless demand that people who resort to such means for the purpose of avoiding taxes pay the “proper amount.” In other words, the government will somehow get what it wants, law or no law. As the reporter of the Asahi article points out, many realtors have been promoting these schemes for years in order to sell condominiums, but now that it seems the government is looking into the practice, they have to find another way to help wealthy buyers use real estate to dodge inheritance and gift taxes.
Philip Brasor and Masako Tsubuku blog about Japanese housing at www.catforehead.wordpress.com.