We have a quiz for you. Don’t scroll down and look at the numbers below just yet.
Age 65 is a commonly-cited retirement age (for example, it’s the default age to start receiving a Japanese National Pension [国民年金, Kokumin Nenkin]). What is the probability of reaching age 65 for ____?
1. American men?
2. British men?
3. Japanese men?
4. American women?
5. British women?
6. Japanese women?
1. Americans (♂): 80%
2. British (♂): 87%
3. Japanese (♂): 89%
4. Americans (♀): 87%
5. British (♀): 91%
6. Japanese (♀): 94%
Now, what percentage of people worldwide are predicted to reach 100? 110?
In other words, at least 4/5 of us are going to have “good, long lives,” in which we have the opportunity to build considerable wealth through hard work, thrift, and investments. Second, we might not like to think about it, but we’re all going to die.
Presumably you have loved ones and want to make sure they’re comfortable. If you can leave them a sizable inheritance, this will help ensure this.
Are you planning to retire in Japan? If so, Japanese inheritance tax laws apply to you. They’re complicated, frustrating even the mayor of Tokyo. Even if you don’t plan to retire in Japan and move outside of Japan, they may STILL apply to you! We explain whether you’ll owe Japanese inheritance tax, how much it’d be by default, and how much you can save by using real estate to reduce inheritance tax legally or avoid it altogether.
How Inheritance Tax Works in Japan
Japanese inheritance tax applies to Japanese AND foreigners. The heir(s) (surviving spouse/descendant[s]) pay. ¥30 million (~$276,000) is exempt. Your heir(s) will need to pay it within 10 months of your passing. One can use a local tax representative for this. The tax rate is progressive, ranging from 0% (if under the exemption amount) to 55% at the highest tax bracket:
Which foreigners have to pay Japanese inheritance tax, and which are exempt?
If you’ve lived for less than 10 years with Japan as the “center of your life”, your heirs are exempt. You’re not considered “long-term”. If you’ve lived for 10+ years with Japan as the “center of your life,” then you may have to pay it. What is it, exactly, that determines whether, Japan was the “center of your life?” Several factors include: having a Japanese address, holding Japanese permanent residency, and location of assets during that period of time.In other words, if you’ve lived in Japan for 10+ years, are a permanent resident (永住権者, eijūkensha), and keep most of your assets in Japan, and still live in Japan, then it’s pretty simple: if you passed away now, your heirs would need to pay it. On the other end of the spectrum, if you just studied abroad in Japan for a year and went home, then they wouldn’t.
However, things get more confusing in between. What if you have a home in Japan and most of your assets are in Japan, too, but you were never granted permanent residency? What if you have permanent residency and a home, but most assets were overseas? What if you have permanent residency and most assets are in Japan, but you and your spouse are enjoying retirement in your deluxe RV, as nomads? Then things get complicated. It’s best to consult a tax professional.
Tale of Two Tail Rules
For determining applicability of inheritance tax, there was a “Five-Year Tail Rule.” A foreigner’s heir(s) would only have to pay inheritance tax if said foreigner had been in Japan for 10 of the past 15 years. However, many considered this draconian/unfair. E.g., if John lived in Tokyo from ages 59-69, then moved back to Alabama, passing away at 73 and 11 months, his children (who’d never lived in Japan) might have had to pay up to 55% tax on some portions of the inheritance (including assets completely unrelated to Japan) to the government of Japan, even though they’d never even visited and John hadn’t lived there since his 60s. They might even have to pay up to 55% of the value of his Alabama home to the government!
To avoid scaring away foreign investors and talent, a new rule has since replaced that rule, effective from March 1, 2018. It shortens the tail from 5 years to 2 years: the “Two-Year Tail Rule.” Another improvement: they no longer tax foreign property.
Some people were caught in the transitional phase. For them, there is a grace period.
Using Real Estate To Reduce Inheritance Tax
Above the ¥30,000,000 exemption amount, there is a major difference between passing on ¥10,000,000 (cash) to one’s heirs and passing on ¥10,000,000 in real estate. ¥10,000,000 worth of real estate could have a tax-assessed value of only ¥5,000,000. Because tax-assessed value is usually much lower than actual value. Therefore, inheritance tax on ¥10,000,000 (cash) would be substantially higher than on ¥10,000,000 worth of real estate.
This is a common strategy for middle-class and wealthy Japanese to pass on inter-generational wealth. Imagine that Asako, a kindly obaasan, has ¥40,000,000 that she wants to pass onto her son, Haruto. If she does it in cash:
¥40,000,000 inheritance – ¥30,000,000 exemption = ¥10,000,000 taxable inheritance
¥10,000,000 taxable inheritance × 10% inheritance tax = ¥1,000,000 in inheritance taxes Haruto has to pay
Instead, Asako decides to buy a house with ¥20,000,000 of that. This splits the inheritance into cash (¥20,000,000) and a house (¥20,000,000). The house is actually worth ¥20,000,000, but has a ¥10,000,000 tax-assessed value because in Japan, tax-assessed values are usually much lower than the actual property values.
Therefore, as the National Tax Agency sees it, the assets Asako will pass on:
¥20,000,000 in cash + ¥10,000,000 in real estate = ¥30,000,000.
The exemption is ¥30,000,000, so Haruto does not have to pay any taxes on the inheritance. However, Haruto receives assets worth ¥40,000,000, and avoids ¥1,000,000 in inheritance tax, legally. He manages to reduce inheritance tax to zero.
This example used a small amount for simplicity. However, if Asako were richer, if she were bequeathing ¥400,000,000 instead, the effect of lowering taxable value through real estate would be much more pronounced.
The government is reforming inheritance tax laws. For instance, in 2015, Prime Minister Shinzō Abe’s government passed a law that increased inheritance taxes on the wealthy. Furthermore, it might not be as easy to acquire a mortgage (which confers tax benefits during the inheritance process) in the future. In regard to this, a senior Bank of Japan official stated “Some banks have a higher ratio of real estate finance and have lax screening processes.” Hence he implied that in the future, the government will tighten a few screws.
Inheritance tax threatens your being able to take care of your survivors. In Japan, it is high: up to 55% (highest tax bracket). Even if you are a foreigner, it does not mean you are exempt. Rather, how long you spent in Japan and your status in Japan during that time could make you liable. However, real estate could significantly reduce the inheritance tax your spouse/descendants will pay. Additionally, the government of Japan is increasing inheritance tax and making easy mortgages a thing of the past. Therefore, it’s prudent to start thinking about how to reduce inheritance tax sooner rather than later.