Overview of tax and legal issues non-residents should consider

Many non-French residents wish to acquire a secondary home in France, in the mountains, by the sea or in town, for example in Paris. Real estate is subject to various taxes in France, whether during acquisition with registration fees, annually with property tax, wealth tax and income tax or capital gains tax. Additionally, the transfer to the next generation entails the payment of inheritance or gift taxes. For these reasons, it is essential, before an acquisition, to pay particular attention on how the purchase should be structured.

 

A.      FORMAL PROCESS TO PURCHASE PROPERTY IN FRANCE

Purchasing property in France, as in other European countries ruled by civil law, is a formal process, with clearly defined steps and participants.

 

Step one: the pre-contract (preliminary agreement)

The pre-contract contains the terms and conditions of the transaction: price, terms of payment and transfer of the property, furniture and various objects that the buyer receives and conditions for cancellation. It can be drawn up as a private document or as an officially recorded instrument. The pre-contract is as important as the final contract. Although the pre-contract can be drawn up by the seller and buyer, the involvement of a notaire (French solicitor) is strongly advised to ensure the instrument is correctly prepared.

The notaire(s) can be freely chosen. The seller and buyer can each involve their own notaire without increasing costs because the notaires will share the fees.

 

Time limit for withdrawing from the agreement

At the signing of the pre-contract, the notaire provides the buyer with a certificate stating the buyer has a seven-day period within which to withdraw from the contract.

 

The pre-contract: promesse unilatérale de vente (unilateral promise to sell) or compromis de vente (provisional sales agreement)

The compromis is a promise to sell and involves reciprocal obligations that are tantamount to a sale.

The seller and buyer cannot release themselves from the agreement except in the event of non-fulfillment of any of the conditions of the sale. Buyers generally provide a deposit of 5% to 10% of the price, which is forfeited if they fail to make the purchase.

The promesse unilatérale de vente only commits the seller to sell a specific property, at a specific price, on a specific date. It does not commit a buyer to purchase the property.

If a buyer decides against purchasing, he or she must give the seller an indemnité d’immobilisation (compensation for being prevented from making a sale to another party), which represents 10% of the price or less that was left with the notaire upon the signing of the promesse. This amount will be credited toward the sale price if the sale goes through.

However, thanks to the loi Scrivener (a French law enacted to protect consumers), when a buyer has applied for a loan, the compromis or promesse is conditioned on the loan being obtained. If a buyer does not obtain the loan, he or she owes neither a penalty nor an indemnity; the pre-contract is null and void.

To further assure fairness, the pre-contract stipulates the maximum lending rate that a buyer is required to accept, the name of the bank to which the buyer has applied for the loan and the deadline for obtaining the loan.

 

Step two: between the pre-contract and the contract

Between the pre-contract and the final signing of the sale, the buyer must obtain the loan and complete certain steps and verifications. The buyer then provides the notaire with the certificate and the acceptance of the loan application.

Notaires carry out certain formalities during this period that ensure the enforceability and the balance of the contract. They also investigate the possible occurrence of a droit de préemption urbain (DPU) (municipal right of first refusal). As for buyers of undeveloped land, they often will purchase property, with the sale contingent upon obtaining a building permit. Therefore, between the pre-contract and the final contract, they must apply for a building permit and make sure that the authorization is clear of any objections or legal encumbrances.

 

Step three: signing the final contract

The acquisition of real estate in France must take place in the presence of a notaire. Once the conditions of sale have been satisfied, the seller and buyer sign in the presence of a notaire the instrument that officially records the change in the property’s ownership and implements payment of the sale/purchase price.

 

Step four: after the sale

The deed of sale is lodged with the mortgage registry that records all the transactions. Some months later, the notaire sends the authenticated copy that constitutes the buyer’s certificate of title. The original of the official instrument remains for 100 years at the office of the notaire that received it.

 

B.      REGISTRATION, NOTARY FEES AND VALUE ADDED TAX (VAT)

Registration fees amounting to a percentage of the purchase price (5.09% to 5.80% depending on the location of the property) are due:

  • At the time of registration of the conveyance of a French real estate asset.
  • Regardless of where the buyer and seller reside, for tax purposes, in France or another country.
  • Regardless of whether the real asset is acquired directly by an individual or through a company primarily dealing in French or foreign real estate.

New buildings are not subject to registration fees, but are subject to VAT.

Frais de notaire (fees, including taxes payable, calculated by the notaire).

The fees received by notaires go only partially to the notaires themselves. Most of the fees they collect are turned over to the government for various purposes such as registration fees, mortgage registry fee and real estate registration tax. All in all, registration duties and notary fees represent approximately 7% of the price.

 

C.      INCOME TAX ON REAL ESTATE INCOME

The income derived on property in France is subject to income tax and should be declared in France. Once a property is rented out, it will become necessary to file a French tax return. This annual tax declaration is mandatory and must give the tax authorities complete information concerning the taxpayer's identity and marital and family situation, as well as the taxpayer’s income from French sources.

French income tax is payable by non-residents at progressive rates after allowable deductions for expenses incurred in connection with letting or maintaining the property (for example, interest payable on a local mortgage, repairs and maintenance, certain real estate taxes, and management expenses such as concierge and security).

The general rule is that the taxable income of a non-resident taxpayer is subject to a minimum tax rate of 20%. However, if the taxpayer can justify that the effective rate of tax on their worldwide income would be below 20% if they were a French resident, this lower effective tax rate can apply instead of the 20% minimum rate.

Non-residents are liable to the social tax at a flat rate of 17.2%. However, if they can justify that they are affiliated to a social security regime within a country of the European Economic Area or Switzerland, the social tax rate is 7.5%.

Furnished and unfurnished properties are treated differently for tax purposes.

  • Unfurnished property is taxed on income, less deductions for allowable expenses, and is regarded as non-commercial property (“régime réel”). Non-residents can benefit from a simplified scheme (“régime micro foncier”) where, when income is <€15,000, a deduction of 30% for related costs is permitted in determining taxable income.
  • Furnished property is treated as commercial property. Non-residents have a choice in the method they use to determine taxation. Where income <€70,000, a deduction of 50% for related costs is permitted in determining taxable income. For income > €70,000, or where an individual chooses to opt out of the simplified scheme, taxation is calculated on an actual receipts/costs basis (“régime normal”).

 

D.      French Real Estate Wealth Tax (IFI)

Non-resident individuals are liable for the Impôt sur la fortune immobilière (IFI,) on the net asset value of their French real estate assets above €1,300,000.

The taxable base is calculated as of 1 January each year, based on the market value of each property after deducting defined property’s liabilities. Once the threshold of €1,300,000 is reached, the tax schedule applies.

Very few tax treaties make it possible to escape French Real Estate Wealth Tax.

IFI applies to:

  • Real estate properties.
  • Real estate rights.
  • Shares in French or foreign companies or any kind of structure (with the assessable value limited to the extent of the value of the underlying real estate or rights owned directly or indirectly by the company).

The taxable value of the shares will be assessed as follows:

  • Step 1: shares taken at their market value, with qualifying liabilities of the company deducted from the calculation. The following liabilities are non-deductible:
    • Debts entered into by the company to purchase the real estate asset from the taxpayer or a member of the tax household.
    • Debts entered into by the company issued by the taxpayer or a member of the tax household.
    • Debts entered into by the company issued by another company that is controlled by the taxpayer or a member of their family.

These exceptions can be deducted from the market value of the shares of the company if the taxpayer can justify that such loans are not motivated by a predominantly tax-avoidance purpose.

  • Step 2: the pro rata value of the company’s real estate assets is then applied to the valuation, excluding:
    • Real estate assets owned by operating companies and used by them for the purpose of their activities.
    • Shareholding in operating companies in which the taxpayer holds less than 10% capital or voting rights.

Exemptions:

  • Shares in an operating company in which the taxpayer holds less than 10% capital or voting rights.
  • Real estate belonging to an operating company that is used for the purpose of that company’s business activities.
  • Holding in a French listed real estate investment company (SIIC) in which the taxpayer has less than 5% capital or voting rights.
  • UCIs (Undertakings for Collective Investments) and investment funds: taxation under the IFI excludes holdings below 10% in UCIs and investment funds where the assets of which comprise less than 20% taxable real estate.
  • Real estate assets belonging to taxpayers for whom that real estate forms part of their professional activity (under special conditions).
  • Individuals relocating to France who have not been a French resident during the past five years are exempted from IFI on their real estate assets located abroad for the five first years of their French residency. After five years’ residence in France, the IFI will apply to their worldwide real estate holdings.

All debts in existence as at 1 January of each year entered into by the taxpayer are 

  • Financing the purchase of a real estate property.
  • Financing repair and maintenance expenses of a real estate property.
  • Expenditure relating to the improvement, construction, reconstruction or expansion of real estate property.
  • Acquisition costs of units or shares in a fund or company, prorated to the value of taxable real estate assets held.
  • Land taxes borne by the landlord and the IFI (the personal tax due for income generated by real estate and housing taxes are not deductible).

By exception, a number of loans are not deductible:

  • Family loans subscribed directly or indirectly from a member of the tax household.
  • Family loans subscribed directly or indirectly from the family group except to justify normal conditions of the loan.
  • Loans from a company controlled by one of the persons mentioned above.

Limitations:

  • Bullet loans contracted for the purchase of real estate are deductible but a tax notional amortization over the period of the loan has to be applied.
  • Loans that do not provide a term for repayment of principal (that is, on demand facility) are deductible with a notional amortization of 1/20th per year since the payment of the loan.
  • When the value of taxable assets exceeds €5,000,000 and the total amount of deductible debts exceeds 60% of this value, the debts would only be deductible above €5,000,000 by 50%, unless the taxpayer confirms that the debts were not contracted mainly for a tax avoidance purpose.

 

E.      Exemption from the 3% annual tax

Companies or trusts (in fact all legal entities) that own French real estate, directly or indirectly, are subject to an annual tax of 3% of the market value of the property. There are many cases where exemption can be claimed but very often a tax form needs to be filed, every year. This tax does not discharge the company to pay other taxes, and likewise, this 3% tax is not deductible from a company’s profit or other taxes.

Certain companies are exempt from this annual tax:

  • Companies that do not have the majority of their French assets invested in French real estate (for example, when more than 50% of the company’s assets consist of French financial investments such as French mutual funds, shares issued by a French company, government bonds or French corporate bonds). In this case, the company is not primarily dealing in real estate and is therefore not subject to the 3% annual tax.
  • Companies located in a country that has a treaty with France providing for mutual administrative assistance. In this case, exemption is possible if certain conditions are fulfilled. The identity and certain details concerning the shareholders or the owner, such as the number of shares they own and their rights, must be disclosed to French authorities each year. If the shareholder is a company or a company chain, the ownership details must also be disclosed.
  • Companies located in a country that has a treaty with France providing for mutual administrative assistance, or based in a country that has a treaty with France, including a non-discrimination clause to disclose information about its assets and its shareholders (those who hold 1% or more of the shares), within two months following the acquisition.
  • Companies located in a country that has a treaty with France providing for mutual administrative assistance, or in a country that has a treaty with France that includes a non-discrimination clause disclosing information each year about its assets and its shareholders (who hold 1% or more of the shares) to the administration.
 

F.      CAPITAL GAINS ON THE SALE

Non-residents — French or foreign — who own real estate in France are subject to special capital gains tax treatment, including:

1.       Income tax at a flat rate of 19%.

2.       Social tax at a flat rate of 17,2% or 7,5%.

3.       Extra tax of 2% to 6% for capital gains exceeding €50,000.

French capital gains taxes apply on any gain made by individuals on:

a.       The sale of French real estate own directly.

b.      The sale by a tax-transparent SCI of French real estate.

c.       The sale of shares of listed real estate companies such as SIIC, Sppicav (or foreign equivalent) when the seller owns more than 10%.

d.      The sale of shares of a French or foreign company qualified as a SPI. A SPI is an unlisted entity composed for more than 50% of French real estate or of rights relating to French real estate.

Non-residents are liable to the social tax at a flat rate of 17.2%. However, if they can justify that they are affiliated to a social security regime within a country of the European Economic Area or Switzerland, the social tax rate is 7.5%.

The taxable base is subject to progressive allowances depending on the length of the ownership, resulting in exemption from the tax after 30 years of ownership:

The designation of an accredited tax representative is mandatory when the seller is not domiciled within the European Economic Area (Liechtenstein being excluded of the EEA for this provision).

In addition to the above taxation, an extra tax applies on net gains (after application of the progressive allowances) which exceed €50,000. The rates are between 2% and 6% (the higher rate of 6% applies on gains exceeding €260,000).

 

Exemptions:

Sale of the former principal private residence in France

Since 1 January 2019, the sale of the former principal private residence in France is exempted if:

  • The seller is a resident of a country member of the UE or which has signed with France a treaty aimed to avoid tax evasion.
  • The sale is effective by at least 31 December of the year following the year of relocation out of France.
  • Between the relocation and the sale, the property must not be rented out or be lent for free to anybody.

 

Dwellings in France owned by non-residents

Notwithstanding the general rule imposing capital gains tax on the sale of French real estate, a special rule applies to:

  • nationals of the EU, Iceland, Norway and Liechtenstein; and
  • nationals of other countries provided that they can present a right to a clause of non-discrimination.

This rule exempts them from capital gains tax on the sale of their dwelling in France. The exemption applies to the sale of one property, starting 1 January 2014, and is subject to two conditions:

1.       The sellers were continuously domiciled in France for at least two years, at any time before the sale.

2.       The sale:

a.       is made at the latest on 31 of December of the fifth year following the exit of France by the seller (whether the dwelling is rented or not); or

b.      concerns a house that has not been rented since 1 January of the year preceding the sale (hence the need to provide proof of two years’ payment of the residence tax).

This exemption is nevertheless limited to a fraction of €150,000 of the capital gain (after taking into account of the applicable allowances), the surplus of the gain remaining taxable.

 

G.     TRANSFERRING PROPERTY

In the event of death:

  • French real estate is subject to transfer taxes (inheritance tax) even if the heir is not a French resident.
  • Assets that are invested outside of France are subject to French tax when the heirs are French residents or have been residents for six years during the 10 previous years.
  • The net market value is the basis for French inheritance tax.
  • Some principles of French inheritance law do not exist in other countries, such as the “réserve héréditaire” (that is, a forced portion reserved for heirs).
  • France has signed 35 tax treaties intended to avoid double taxation in relation to inheritance taxes but only seven in relation to gift taxes.

 

French inheritance tax normally applies at progressive rates.

  • In the direct line (transfers to children and parents), the rates rise from 5% to 45%, depending on the value of a beneficiary’s share of the estate (the marginal rate of 45% applies on a share exceeding €1,805,677).
  • Death transfers between spouses are not taxed, and assets that pass to an unrelated beneficiary are taxed at a flat rate of 60%, regardless of their value.
  • Broadly speaking, the rates applying to other family members vary between 35% and 55%.

French inheritance tax can also apply on assets passing through a trust at flat rates which can be very high (up to 60% in certain cases).

Under French law, individuals cannot dispose of his assets on his death as they wish, and cannot deprive certain heirs (notably children) from taking up some part of their estates. The use of a company to own French real estate prevents the application of these restrictive rules which are often not acceptable to foreigners. In accordance with French Private International Law principles, shares of companies are characterized as “movable” assets, and so are dealt with in accordance with the succession law of the State in which an individual is habitually resident at the time of his or her death.

 

H.     SOCIETE CIVILE IMMOBILIERE (SCI)

The Société Civile Immobilière* (SCI) — in English a “non-trading real estate investment company” — is a fairly common method of holding a real estate asset in France; French residents employ it, but it also can be useful for non-residents.

  • A SCI is generally a tax-transparent company that can opt (irrevocably) to be subject to corporate income tax.
  • When the property is an asset to which a family holds rights of enjoyment, the transparent SCI is a simple holding method without any tax implications.
  • The company does not receive rental income and therefore has no tax to pay on rental income.
  • An SCI is a useful method of organization, for example, for the purpose of transferring shares to several children (through a gift or otherwise), while leaving the management of the property to the parents as managers of the non-trading company.
  • Owning real estate through an SCI may allow non-residents to avoid the French réserve héréditaire rule that generally applies only to directly held real estate assets.

 

Sources:

2020 Income tax rates: Loi 2019-1479 du 28-12-2019 art. 2, I-3°-a.

Wealth tax “IFI” rates: art. 977 Code Général des Impôts