Tax-saving model: rules for renting to relatives
Discounted rental to relatives with its advantageous tax regulations offers the opportunity to claim losses from renting and leasing. These usually result from depreciation and interest on loans in connection with reduced rent. If you comply with certain rules when renting to children, you can deduct the expenses in full as advertising costs while only taxing the lower rental income. The tax saving model also works when renting to dependent children.
There is an important change from 1 January 2021:
- If the agreed rent is at least 66% of the local market rent, the expenses can be deducted in full as advertising costs.
- If the agreed rent is between 50% and 66% of the market rent, the intention to generate income must be checked, and a profit forecast is required:
- If the profit forecast is positive, the advertising costs can be deducted in full.
- If the profit forecast is negative, the advertising costs must be divided and only partially deducted.
- If the agreed rent is less than 50% of the local market rent, the use must be divided into a paid and an unpaid part. The expenses can only be deducted as advertising costs corresponding to the paid part.
Currently, the Federal Fiscal Court has ruled that discounted rental to a dependent child can also be recognised for tax purposes if it withstands a so-called third-party comparison. This means that the rental agreement has been legally agreed and both its design and the actual implementation correspond to what is customary between strangers. This requires that the main obligations of the contracting parties have been clearly and unambiguously agreed and implemented accordingly, even when renting to relatives. "Strict requirements are placed on the proof of the seriousness of contractual arrangements between related persons" (BFH ruling of 16 February 2016, IX R 28/15).
In the case of the ruling, the rental agreement with the child was not recognised because the daughter had not actually paid any rent. Instead, the parents offset the rent against the daughter's maintenance claim and only paid her the difference in cash. This is the provision of maintenance in kind in the form of living space. There was no reduction in assets for the daughter as a tenant and no increase in assets for the parents as landlords. Since there is no paid transfer of use and the rental relationship is not recognised, the expenses or loss were not recognised as advertising costs.
Instead of providing the child with the apartment as maintenance in kind and offsetting the rent against the child's maintenance claim, it is more tax-efficient to pay the child cash maintenance, from which they can then pay their rent for the apartment.
The local rent can generally be found in the local rent index. But what applies if there is a comparable apartment in the same building that is rented to third parties and whose rent differs from the local rent index? Should this comparative rent be used for checking the 50% or 66% limit, or still the rent index?
In October 2019, the Thuringia Finance Court ruled that for comparison with the local market rent, the rent demanded by the landlord from a third-party tenant using a comparable apartment in the same building should be used (ruling of 22 October 2019, 3 K 316/19). An appeal was lodged against the ruling at the Federal Fiscal Court. And lo and behold: the landlord was successful.
According to the highest financial judges: The local market rent for checking the 66% limit is generally to be determined based on the rent index. If a rent index cannot be used or is not available, the local market rent can be determined by an expert opinion, information from a rent database, or based on the rents for at least three comparable apartments (BFH ruling of 22 February 2021, IX R 7/20).
According to the Baden-Württemberg Finance Court (ruling of 22 January 2021, 5 K 1938/19), a total surplus forecast is exceptionally required despite compliance with the 66% limit if it is a rental of an elaborately designed residential building, in this specific case a single-family house with well over 250 sqm of living space. However, whether this view can be maintained must now be decided by the Federal Fiscal Court. The appeal is pending under the reference IX R 17/21.
At first glance, one might consider the view from Baden-Württemberg to be hardly tenable, as the tax regulation is actually clear and was also clear in the past. Section 21 (2) sentence 2 of the Income Tax Act states: "If the remuneration for permanent rental of a dwelling is at least 66% of the local rent, the rental is considered to be for remuneration." But there is indeed case law from the BFH in the past where it was of a similar opinion to the Baden-Württemberg Finance Court or at least signalled that in exceptional cases a total surplus forecast might be appropriate (e.g. BFH ruling of 30 September 1997, IX R 80/94 and BFH ruling of 6 October 2004, IX R 30/03). The BFH advocates a total surplus forecast if the market rent - this usually means the rent according to the local rent index - does not reflect the "correct" rental value or if, exceptionally, special circumstances speak against the existence of an intention to generate a surplus.
However, the relevant BFH rulings are somewhat outdated, and most recently the BFH has spoken in favour of the basic approach of the rent index if one is available (BFH ruling of 22 February 2021, IX R 7/20). So, it will be interesting to see how the BFH will decide now.
(2023): Tax-saving model: rules for renting to relatives
Be cautious with reduced-rate rentals: Include furnishing surcharge!
In the case of reduced rent for relatives, expenses can be fully deducted as income-related expenses if the agreed rent is 50% (with surplus forecast) or at least 66% (without surplus forecast) of the local market rent (§ 21 para. 2 EStG). The local market rent can generally be found in the local rent index. When comparing the "agreed rent" and the "local market rent", the paid basic rent plus surcharges should be compared with the achievable local basic rent plus apportionable costs for comparable apartments in terms of type, location, and equipment. But what applies if an apartment is partially or fully furnished?
Currently, the Federal Fiscal Court has ruled that when renting furnished or partially furnished apartments, a furnishing surcharge should generally be applied, as such rentals are regularly associated with increased utility value, which is often reflected in a higher local rent. However, such a furnishing surcharge should only be considered if it can be determined from a local rent index or market-realised surcharges. Determination in any other way is not permitted (BFH ruling of 6.2.2018, IX R 14/17).
The case: The couple rent an 80 sqm apartment to their son at a reduced rate, which is equipped with a new fitted kitchen. They also provide him with a washing machine and dryer for use. The tax office increases the local comparative rent by a furnishing surcharge for the fitted kitchen, washing machine, and dryer in the amount of the monthly depreciation, thus arriving at a remuneration rate below 66%. Consequently, the claimed income-related expenses were reduced accordingly. The tax court also approved a furnishing surcharge and set it at the amount of the monthly depreciation plus a profit margin of 4%.
According to the BFH, the local rent index should be used to determine the furnishing surcharge and the local rent:
- If the rent index provides for a percentage surcharge or an increase in the equipment factor through a points system for a provided fitted kitchen, this increase is considered market-standard.
- If nothing can be found in the rent index, a furnishing surcharge realisable on the local rental market should be considered.
- If a market-standard utility value for the provided furniture cannot be determined, a furnishing surcharge is not applicable. In this case, the local market rent without furnishing should be used.
- NOTE: It is not permissible to derive a furnishing surcharge from the monthly amount of linear depreciation for the provided furniture and furnishings. The application of a percentage rental yield surcharge is also not permitted.
Tip: For furnished rentals, you should agree and specify basic rent, surcharges, and furnishing surcharge separately in the rental contract. Ensure that the amounts are sufficiently high to exceed the relevant threshold of 50% / 66%. If the "agreed rent" is at least 50% / 66% of the "local market rent", you can deduct 100% of the rental expenses as income-related expenses. Use the above-mentioned guidelines provided by the BFH in its new ruling to determine the furnishing surcharge.
The local rent can generally be found in the local rent index. But what if there is a comparable apartment in the same building that is rented to third parties and its rent differs from the local rent index? Should this comparative rent be used for the 50 or 66 percent threshold test, or still the rent index?
In October 2019, the Thuringia Finance Court ruled that for comparison with the local market rent, the rent demanded by the landlord from a third-party landlord using a comparable apartment in the same building should be used (ruling of 22.10.2019, 3 K 316/19). An appeal was lodged against the ruling at the Federal Fiscal Court. And lo and behold: the landlord was successful.
According to the highest financial judges: The local market rent for checking the 66 percent threshold should generally be determined based on the rent index. If a rent index cannot be used or is not available, the local market rent can be determined by an expert opinion, information from a rent database, or based on the fees for at least three comparable apartments (BFH ruling of 22.2.2021, IX R 7/20).
According to the Baden-Württemberg Finance Court (ruling of 22.1.2021, 5 K 1938/19), a total surplus forecast is exceptionally required despite compliance with the 66 percent threshold if it involves the rental of an elaborately designed residential building, in this specific case a single-family house with well over 250 sqm of living space. However, whether this view can be upheld must now be decided by the Federal Fiscal Court. The appeal is pending under ref. IX R 17/21.
At first glance, the view from Baden-Württemberg may seem hardly tenable, as the tax regulation is actually clear and was also clear in the past. § 21 para. 2 sentence 2 EStG states: "If the remuneration for permanent rental of a dwelling is at least 66 percent of the local rent, the rental is considered remunerated." However, there is indeed case law from the BFH in the past where it was of a similar opinion to the Baden-Württemberg Finance Court or at least signalled that a total surplus forecast might be appropriate in exceptional cases (e.g. BFH ruling of 30.9.1997, IX R 80/94 and BFH ruling of 6.10.2004, IX R 30/03). The BFH advocates a total surplus forecast if the market rent - which usually means the rent according to the local rent index - does not reflect the "correct" rental value or if, exceptionally, special circumstances speak against the existence of an intention to generate surplus.
However, the relevant BFH rulings are somewhat outdated, and most recently, the BFH has advocated the fundamental use of the rent index if one is available (BFH ruling of 22.2.2021, IX R 7/20). It will be interesting to see how the BFH will now decide.
(2023): Be cautious with reduced-rate rentals: Include furnishing surcharge!
What do I need to know about rental income?
As a landlord, you must declare the basic rent and any service charges passed on to tenants as additional income. The costs incurred in this context can be deducted as income-related expenses.
Examples of rental income:
- Rental income for flats or rooms
- Rental income for garages/parking spaces
- Service charges passed on to the tenant
- Rent for advertising spaces and vending machine sites
- Interest on credit balances from building society contracts
- Compensation payment from a tenant for early termination of the lease
- Leases for undeveloped land
- Income from a hereditary building right
If rental income is below the 520 Euro annual threshold (e.g. for subletting), you can omit this information from your tax return. Income up to this threshold from temporary letting is exempt from income tax. This also applies to the temporary subletting of parts of your own rented flat. In this case, no corresponding income-related expenses can be claimed.
Note: From 1 January 2024, a new tax exemption threshold for rental income is to be introduced: Income from renting and leasing will remain tax-free if the total income is less than 1.000 Euro (§ 3 No. 73 EStG, introduced by the "Growth Opportunities Act").
(2023): What do I need to know about rental income?
When is accommodation provided at a reduced rate?
If you have income from properties rented to relatives, these are subject to special income tax scrutiny. The tax office particularly checks whether the property was rented at a reduced rate. There is an important change from 1 January 2021:
- If the agreed rent is at least 66% of the local market rent, the expenses are fully deductible as advertising costs.
- If the agreed rent is between 50% and 66% of the market rent, the intention to generate income must be examined, and a profit forecast is required:
- If the profit forecast is positive, the advertising costs are fully deductible.
- If the profit forecast is negative, the advertising costs must be apportioned and are only partially deductible.
- If the agreed rent is less than 50% of the local market rent, the use must be divided into a paid and an unpaid part. The expenses are only deductible as advertising costs in proportion to the paid part.
Important: If the rent is at least 50% but less than 66% of the local rent, a total surplus forecast must be carried out:
If this total surplus forecast is positive, the intention to generate income is assumed for the provision of reduced-rate housing, and the full deduction of advertising costs is possible. If the total surplus forecast is negative, the intention to generate income is only assumed for the paid part. Advertising costs can be partially deducted for the paid part.
The total surplus forecast for income from renting and leasing is carried out according to long-standing and established BFH case law. The BMF letter of 8 October 2004 (BStBl 2004 I p. 933) remains applicable.
When renting furnished or partially furnished flats, it may be necessary to include a surcharge for the furnishings to determine the local market rent. Such a furnishing surcharge must be considered according to the Federal Fiscal Court ruling of 6 February 2018 (IX R 14/17) if it can be determined from a local rent index or surcharges achievable on the market. Other methods of determination are not permissible. In particular, it is not permissible to derive a furnishing surcharge from the monthly amount of the linear depreciation for the furniture and furnishings provided. Nor is it permissible to apply a percentage rental yield surcharge.
The 50% and 66% thresholds apply only to the rental of flats, not to commercially or freelance used premises.
(2023): When is accommodation provided at a reduced rate?
