The Japanese government has begun internal discussions to amend the rules for how high-rise residences are valued for Japanese inheritance tax, with the aim of closing a loophole that creates an incentive for wealthy parents to buy properties on higher floors as a way to transfer more assets to their children. The current rules allow people who inherit higher-floor apartments to significantly reduce their inheritance tax basis.
The Japanese Ministry of Internal Affairs and Communications and the National Tax Agency are discussing changes to the valuation standards set forth in the applicable Ministry of Internal Affairs and Communications ordinance, with the goal of having a first draft of the amendments by late 2016 and implementing the changes in January 2018.
It is expected that the relevant standards regarding how fixed asset tax is calculated for high-rise residences will be amended as well.
Arbitrage on condominiums located on higher floors
Currently residences in tall buildings are often bought and sold in Japan for the reduced inheritance tax effect.
The point is that under the applicable ministerial ordinance for appraising inheritance tax, buildings as a whole are appraised, and then each residence in the building is apportioned equally the same tax basis based on floor space.
For example, if a twenty-story building with one residence per floor is valued at “200”, each residence per floor would be valued at “10” for inheritance tax purposes; 200 divided by 20 apartments = 10.)
Nevertheless, the actual market value of high-rise residences depends not only on floor space, but also on which floor the residence is located: higher floors have better views, better sunlight, etc. and thus a higher market price.
For tall buildings in the most desirable locations, the market price for residences in the tallest floors can be many multiples of the market price for lower floor dwellings, and 2 to 3 times the applicable inheritance tax appraisal value.
This creates the potential for an inheritance tax arbitrage. If one buys a high-rise residence on the tallest floor (costing 30 but valued for inheritance tax at 10), when the owner passes away the heir will only pay inheritance tax on 10 (effectively shielding the remaining 20 from any Japanese inheritance tax). And after the fact, the heir can sell the property for 30 if the heir wants more liquidity.
Balancing Act for the Government
There has been a lot of discussion in the last few years of how the consumption tax increase goosed the residential property market here (with many buyers completing deals just prior to the consumption tax being hiked from 5% to 8% in April 2014), but the tax avoidance scheme described above has also stimulated the market for residences a great deal over the last ten years.
The government intends to amend the rules so that the inheritance tax basis will vary depending on the actual market price of the floor that the apartment is located on.
On the one hand, the Japanese government would like to increase tax receipts by limiting the above tax avoidance scheme since it can only be utilized by a select number of wealthy people. On the other hand, the government is aware that it needs to be very careful in changing the rules so that it can maintain property values and positive market sentiment to the extent possible. Accordingly, it has a delicate balancing act to consider.
Source: Nikkei Shinbun, January 24, 2016
Top photo: Shinagawa Intercity building, a mixed-use high-rise (not a residential high-rise) in Tokyo.