Can I deduct the debt interest if I financed the property externally?
You can deduct any interest on debt as income-related expenses if the loan in question is used to finance acquisition or production costs as well as maintenance expenses, etc., for a rented property. You can also deduct other financing costs related to your rented property. These include, for example:
- Registration of a mortgage
- Loan interest before the completion of the property
- Fees and commissions to the bank
- Fees for the notary or land registry office
You can declare the costs in the year in which they were paid in the tax return. You cannot deduct the repayment instalments of your mortgage or loan.
Can I deduct the debt interest if I financed the property externally?
What can I deduct as income-related expenses?
All expenses incurred in connection with the rented property can be deducted as income-related expenses. These include in particular the following costs:
- Administrative costs
- Costs for estate agents, service charges, advertisements or a rental service
- Interest on a loan
- Depreciation
- Property tax
- Bank charges, overdraft interest etc.
- Insurance (liability, fire, water etc.)
- Electricity costs for house lighting
- Heating and hot water
- Costs for sewage, waste disposal, chimney sweep, street cleaning
- Caretaker costs (also property management and cleaning)
- Trips to the property, estate agent or owners' meeting
- Cosmetic repairs
Additional costs that you settle with your tenants can only be declared as income-related expenses in your tax return if you also enter them as income from renting and leasing.
What can I deduct as income-related expenses?
Property sales: Are subsequent debt interest payments deductible?
When selling a rented property, the proceeds are generally used to pay off the remaining loan. However, it may happen that the proceeds are not sufficient to pay off the debt, and the loan must continue to be repaid. This phenomenon is often observed in investment models with worthless properties and investment objects in the new federal states. The following two cases should be distinguished:
(1) Interest on debt for externally financed acquisition/construction costs
If the acquisition or construction costs of the rental property were financed by a loan and the sale proceeds are not sufficient to pay it off, the ongoing interest on debt can be deducted as subsequent income-related expenses for income from renting and leasing. This is because the connection between the remaining loan and the previous rental income continues after the sale if the sale proceeds are not sufficient to repay the loan (BFH ruling of 20.6.2012, IX R 67/10).
It does not matter whether the property is sold within 10 years of its purchase, making it a taxable sale, or whether the sale takes place after the ten-year period and remains tax-free (BFH ruling of 8.4.2014, IX R 45/13).
(2) Interest on debt for externally financed maintenance expenses
If extensive renovation work was financed by a loan, this constitutes maintenance expenses and could be deducted as income-related expenses during the rental period, e.g. flat modernisation, replacement of the heating system, roof renewal.
- If the rental property was sold before 2014, the interest on debt could - and can still - be deducted as subsequent income-related expenses after the end of the rental period or after the sale of the house. How the sale proceeds were used was irrelevant (BFH ruling of 12.10.2005, IX R 28/04).
- If the rental property was sold after 1.1.2014, a stricter regulation applies: Now, interest on debt for loan-financed maintenance expenses after the sale of the rental property is only recognised as subsequent income-related expenses from renting and leasing if the sale proceeds are not sufficient to pay off the loan (BMF letter of 15.1.2014, BStBl. 2014 I p. 108).
Property sales: Are subsequent debt interest payments deductible?
When does the tax office recognise a discount as tax-reducing?
When financing a house or flat through a loan, a discount is often agreed upon. The discount - also known as a damnum - is deducted from the loan amount and is essentially an advance payment on the interest. This reduces the interest rate and the monthly instalments during the period for which the discount is prepaid.
The disadvantage is that due to the undistributed discount, a higher loan amount may need to be taken out, interest paid on, and repaid than with a loan without a discount. However, there is also a significant advantage: if the house or flat is rented out, the discount can be fully deducted as income-related expenses, provided it is "customary in the market" (§ 11 para. 2 sentence 4 EStG).
Since 2004, a discount with a fixed interest rate of at least five years can only be immediately deducted as income-related expenses up to 5% of the loan amount. The amount exceeding this must be spread over the period of the fixed interest rate or - if this is missing - over the term of the loan (BMF letter dated 20.10.2003, BStBl. 2003 I p. 546).
Recently, the Federal Fiscal Court ruled that a discount higher than 5% can still be considered "customary in the market" and therefore deductible as income-related expenses.
Thus, a customary market discount for a loan with a term of more than five years does not need to be spread over the term but can be fully deducted in the year of payment. A discount of 10% for a 10-year loan term can indeed be "customary in the market" and therefore fully deductible (BFH ruling of 8.3.2016, IX R 38/14).
- The term "customary in the market" refers to the specific discount in question. Based on the function of a discount, its market customariness is determined by the amount of the discount in relation to the amount and term of the loan, in relation to current conditions in the credit market: What is customary in the market is determined by current conditions in the credit market concerning the specific financed object. Linking market customariness to a fixed interest rate is not applicable.
- A customary market discount must be distinguished from "unusual" arrangements that do not fall within the usual framework of the current credit market. When this is the case is a matter for the court to assess.
- If an interest and discount agreement is concluded with a commercial bank as with third parties, this indicates market customariness. Given the usual obligation of commercial banks to control risks, interest arrangements agreed with a commercial bank are generally considered to be within the usual framework of the credit market. This presumption can be rebutted if there are special circumstances suggesting that the usual framework of the credit market has been exceeded. Such circumstances may include a particular credit unworthiness of the borrower, special personal relationships between the parties involved, or completely atypical contractual arrangements.
When does the tax office recognise a discount as tax-reducing?
