Spanish Tax implications of a cancellation of a life interest (‘usufruct’) over a property in Spain when the life tenant dies

First of all, we need to understand how the life interest was created as the tax implications of the cancellation on death of the life tenant are slightly different.

1. Life interest created as a result of an inheritance.

Sometimes it is common, especially for Spanish citizens to execute a Spanish Will leaving the life interest over a Spanish property to the spouse and the interest in the remainder to the children of the testator/testatrix.

When the life tenant (‘usufructuary’) dies, the beneficiaries who once acquired bare ownership will now be the owners of full ownership upon the death of the life tenant (‘usufructuary’), producing what is called consolidation of ownership, which occurs by extinction/cancellation of the life tenancy.

When the beneficiaries acquired bare ownership of the property as a result of an inheritance, such acquisition would have been subject to inheritance tax in Spain on the value of the bare ownership (i.e. the value of the share of the property acquired reduced by the value of the life tenancy). Likewise, the acquisition of the life interest by the life tenant would have been subject to inheritance tax in Spain on the value of the life tenancy.

When the life tenant dies, Spanish Inheritance Tax is levied on the taxable event of the consolidation of ownership due to the cancellation of the life tenancy (‘usufruct’).

The reason for this is that the beneficiaries who acquired the bare ownership of the property only paid inheritance tax on the value of such bare ownership and not on the entire value of the property, therefore when the life tenant dies and the life interest is cancelled, full ownership of the property is vested in the bare owner, and such cancellation of the life interest is subject to Spanish Inheritance Tax on the value of the life interest.

2. Life interest created as a result of a property purchase

When the life interest was created as a result of a property purchase, at the time of the life tenant’s death, the cancellation of the life tenancy will be subject to Spanish Transfer Tax payable by the bare owners on the value of the life interest (applying the percentage value of the life interest at the time when it was created to the value that the property has at the time of the cancellation of the life interest).

The reason for this is that the individual who acquired the bare ownership of the property in Spain by purchase subject to a life interest, only paid Spanish Transfer Tax on the value of such bare ownership and not on the entire value of the property, therefore when the life tenant dies and the life interest is cancelled, full ownership of the property is vested in the bare owner, and such cancellation of the life interest created as a result of a property purchase is subject to Spanish Transfer Tax on the value of the life interest.

3. Spanish Transfer Tax and/or Inheritance Tax implications.

In both cases, at the time of the acquisition of the bare property, the tax was not paid on the entire value of the property, but only on the part corresponding to the bare ownership, and therefore not on the value corresponding to the life tenancy, even if the life tenant was subject to payment of the relevant tax (Inheritance or Transfer Tax) on acquisition of the life tenancy.

When the life tenant (‘usufructuary’) dies and the life tenancy is extinguished, the bare owner is vested with the ownership of the property absolutely, and such cancellation of the life tenancy is subject to the relevant tax levied on the value of the life tenancy.

Therefore, even if the cancellation takes place as a result of the death of the life tenant, the tax that the owner who consolidates his ownership by extinction/cancellation of the life tenancy must pay is the same tax that they paid when they acquired the bare ownership of the property.

(a)    If the acquisition of the bare ownership of the Spanish property subject to a life tenancy happens by means of a transfer for value (purchase), when the life tenant dies, the cancellation of the life tenancy over the property in Spain is subject to Spanish Transfer Tax.

To calculate such Transfer Tax, the percentage value of the life tenancy at the time when it was created is taken into account and then applied to the value of the property on the date of death of the life tenant.

The rate of Spanish Transfer Tax is the relevant rate applicable on the date of death of the life tenant.

(b)    If the acquisition of the bare ownership of the Spanish property subject to a life tenancy is by means of an inheritance or a gift, when the life tenant dies, the cancellation of the life tenancy over the property in Spain is subject to Spanish Inheritance and/or Gift Tax.

To calculate such Spanish Inheritance and/or Gift Tax, it is taken into account the value of the life, the relevant tax rate and the tax deductions applicable at the time when the life tenancy was created.

4. Spanish ‘plusvalia’ tax and cancellation of a life interest.

As a result of a new interpretation of the law by the Spanish Tax Authorities since 2022, the cancellation of a life interest is not considered as a new acquisition by the bare owner as it is deemed that the bare owner acquired ownership of the property at the time of acquisition subject to the life tenancy and therefore is not subject to Spanish ‘plusvalia’ tax on cancellation of the life tenancy.

Please do not hesitate to contact Lopez & Moreno Associates if you need advice on the cancellation of a life interest as a result of the death of the life tenant.