When is it worth updating the book value of property inherited or donated to an individual?

The tax impact is always a relevant issue when it comes to transferring real estate.

It is well known that in the case of inheritance and the donation of assets, the Causa Mortis and Donation Transfer Tax (“ITCMD”) applies. ITCMD is a state tax, so each federal entity can set the applicable rate, within the current limit of 8% (eight percent) of the value of the assets transferred.

On the other hand, when buying and selling real estate, two taxes usually apply: the Tax on the Transfer of Real Estate (“ITBI”), which is a municipal tax, and the Income Tax on Capital Gains (“IRPF”).

The IRPF on capital gains is a federal tax with a progressive rate, which starts at 15% (fifteen percent), and the rate is calculated on the difference between the sale value and the acquisition value of the asset.

For example: if you bought an asset for R$100,000.00 (one hundred thousand reais) and, years later, sold it for R$300,000.00 (three hundred thousand reais), the tax will be calculated on the difference between these values – that is, on R$200,000.00 (two hundred thousand reais).

Recently, several disputes have been fought in the courts over the possible cumulation of ITCMD and IRPF in the event of an inheritance or donation.

Although the issue has already been judged a few times by the Federal Supreme Court (“STF”), there is still no decision with general repercussions – which creates a certain amount of legal uncertainty.

The discussion arises because, when the State Revenue Office calculates the ITCMD, it does so based on the “market value” of the property. This market value can be (and tends to be) much higher than the book value, which is the value recorded on the original owner’s tax return. This difference is natural and occurs due to the appreciation of assets – especially real estate.

It is therefore certain that ITCMD will apply to inheritances and donations. The question is: should the IRPF on capital gains also apply?

If so, there would be a calculation of the difference between the market value of the asset and that shown on the donor’s/successor’s tax return.

The argument against cumulation claims that it is unacceptable to talk about an increase in the capital of the person who is transferring an asset without any financial gain. The fact is that the donor or deceased does not realize any capital gain from the transfer.

The argument in favor of cumulation, on the other hand, claims that the capital gain has already been verified over time, so that the transfer of the asset is only used as a time frame for calculating this gain.

In practice, there has been an understanding that involves an important accounting decision that must be made by those who receive a certain asset free of charge.

The logic is that IRPF can only be levied if the recipient of the asset (heir or donee) updates the value of the asset. In other words, capital gains tax can be levied when the recipient declares the asset in their income tax return at its market value, and not at the value previously declared by the former owner.

The definition of this update should be an option for the recipient of the asset, not an obligation.

In principle, therefore, there is an advantage in not updating: you don’t have to pay the tax at the outset. In most cases, when it comes to paying taxes, people prefer to postpone payment rather than make it right away.

However, attention must be paid to the special situation of property received by inheritance or donation.

If the recipient chooses not to update the value of the property to the market value, he needs to be aware that in the future, when he sells the property, the IRPF on capital gains will be levied on the entire difference between the sale value and the book value – which will be out of date.

At first, this doesn’t seem to be a problem. He would only be paying in the future what he didn’t pay in the past, plus what he would have to pay again for the subsequent appreciation.

However, it should be noted that, when calculating the capital gain on the sale of real estate, there are some percentages of reduction that apply, by legal provision, due to depreciation and monetary correction.

The first of these discounts is provided for in Law 7.713 of 1988. It provides for a variable discount for properties purchased up until 1988 – the older the date of purchase, the greater the discount. The discount ranges from 5% (five percent) for properties acquired in 1988 to 100% (one hundred percent) for properties acquired before 1969.

The other reduction percentages are provided for in Law 11.196 of 2005. The law provides for two reduction formulas (FR1 and FR2). These formulas are a little more complex than the fixed table in the 1988 law. However, the important thing to know is that, in any case – including for properties acquired in recent years – there will be a discount on the amount of the IRPF tax base for capital gains.

This discount ends up making a big difference to the final tax bill. As a demonstration of this, we’re going to use the GCAP 2024 program, from the Receita Federal, to do a simulation.

Let’s say that a property was sold on today’s date, 11/28/2024, for R$1,000,000.00 (one million reais). Its purchase price was R$300,000.00 (three hundred thousand reais). Let’s change just one piece of information: the acquisition date.

• If the property was acquired by the seller on 11/28/2001, the total tax due will be R$35,312.32 (thirty-five thousand three hundred and twelve reais and thirty-two cents).
• However, if the property was acquired by the seller on 11/28/2022, the total tax due will be R$96,217.68 (ninety-six thousand two hundred and seventeen reais and sixty-eight cents).

You can see that there is a very big difference in the final value of the tax, just because of the date of acquisition. In the example cited, we are not even using a property acquired before 1988, when an additional percentage reduction would have been applied.

But what is the importance of this in the light of everything we are talking about in this article? Let’s illustrate with a hypothetical case.

Let’s say your father bought a house in 1990. In 2024, he gave it to you as part of succession planning. Now let’s say that in 2030 you decide to sell the house to a third party. What will be the date of acquisition of the property, informed for the purposes of applying the discounts on the capital gains tax at the time of sale?

The date of acquisition is the date on which the property became part of your estate. In other words, in the hypothetical case above, it was 2024.

This means that the IRPF on the capital gain will be calculated on the difference between the sale value and the acquisition value (the value that is in your Income Tax) and that the discounts applied to the calculation will be those that apply up to the date of receipt of the donation.

If, at the time you received the donation, you updated the value of the asset in your Income Tax, you have already paid all the tax that would have been due between 1990 and 2024, and are entitled to a great discount for the depreciation. On that date, you updated the asset’s acquisition value, so when you sell it in 2030, the “acquisition value” will be much higher than if you hadn’t updated it, which means that the capital gain (difference between sale value and acquisition value) will be much lower.

On the other hand, if at the time of the donation you chose not to update the value of the property, you missed the chance to use all the discount that would have applied between 1990 and 2024. So, when you sell the property a few years later, you will pay the difference between the sale price and the original purchase price, made many years ago, but enjoying a much smaller depreciation discount.

You can see, therefore, that in the case studied here, it’s not always a good idea to “play ahead” with paying the tax – because it can end up being much higher.

In summary, it can be said that the older the date of acquisition of the asset being donated, the greater the benefit of updating it.

Similarly, the more likely it is that you will sell the property in the short, medium or even long term, the greater the benefit of upgrading.

Of course, we are talking here about hypothetical facts and general theories.

You should know that, in practice, each case is different. Therefore, this article is not legal advice or an unshakeable rule. It is necessary to understand the client’s wishes and make all the appropriate calculations, analyzing each variable, in order to understand the best tax strategy to adopt.

At RUCR Law we have a specialized team to deal with all these issues.