Rules for renting to relatives

Those who rent a flat to close relatives, such as their own children, can benefit from tax advantages. The prerequisite is that the rental agreement is correctly structured and actually implemented.

Reduced rent: Tax advantages through income-related expenses

Even with a reduced rent, landlords can deduct income-related expenses (e.g. depreciation, interest on debt) for tax purposes. The following applies:

• Rent ≥ 66% of the local market rent: Income-related expenses are fully deductible.
• Rent between 50% and 66% of the local rent: A total surplus forecast is required:
  • Forecast positive: full deduction of income-related expenses
  • Forecast negative: income-related expenses only partially deductible
• Rent < 50% of the local rent: Rental is partially classified as gratuitous. Income-related expenses are only deductible in proportion to the paid rental share.

These rules only apply to the rental of residential property – not to rooms used for commercial or freelance purposes.

Total surplus forecast: When is it necessary?

A total surplus forecast must be carried out if:

• the rent is between 50% and 66% of the local rent
• or in exceptional cases also for rental at more than 66%, e.g. for elaborately designed or very large properties (over 250 m² living space)

The forecast checks whether a profit can be made from the rental within 30 years.

Arm's length comparison: Contract as with third parties

A rental agreement with relatives must withstand the same conditions as a contract with third parties:

• Contract in writing and clearly regulated
• Actual payment of rent
• Implementation as agreed

If, for example, the rent is offset against maintenance, there is no paid rental relationship – income-related expenses are then not deductible (BFH ruling of 16.02.2016, IX R 28/15).

Cash maintenance is better than maintenance in kind

If a flat is provided to the child as "maintenance in kind" (rent is offset against maintenance claim), this is not recognised for tax purposes.
Recommendation: Pay cash maintenance so that the child transfers the rent themselves.

Furnished flats: Consider furniture surcharge

For furnished or partly furnished flats, a surcharge on the local rent can be applied – but only if:

• this surcharge is included in the rent index or
• it is realistically achievable on the market

Not permitted: Surcharges based on depreciation or flat-rate percentage surcharges (BFH ruling of 06.02.2018, IX R 14/17).

How is the local rent determined?

The local rent is usually derived from the local rent index.
Alternatively (e.g. if there is no rent index):

• Expert opinion
• Information from rent database
• Comparison with at least three comparable flats

A single comparable rent in the same building is not sufficient if there is a valid rent index (BFH ruling of 22.02.2021, IX R 7/20).

Special case: Large or luxurious properties

For very large or high-quality flats (e.g. villas over 250 m², swimming pool), a total surplus forecast may be required despite compliance with the 66% limit (BFH ruling of 20.06.2023, IX R 17/21).

• Case study:
  Parents rent three villas to their children, each with > 250 m² living space.
  The rental leads to high losses, which are to be offset against other income.
  → Not allowed, as there is no intention to generate income.
• Reason:
  The market rent often does not realistically reflect the special residential value of such properties.
  Long-term loss-making activity indicates hobby – losses are not deductible for tax purposes.

Rules for renting to relatives

Reduced-rate rental: Comparative calculation with apportionable service charges

Flats are often rented to relatives at a price below the local market rate. Such discounted rentals are advantageous for tax purposes because, on the one hand, only lower rental income needs to be taxed and, on the other hand, expenses can be fully deducted as income-related expenses.

There was an important change on 1 January 2021:

• If the agreed rent is at least 66% of the local market rent, the expenses can be fully deducted as income-related expenses.
• 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 income-related expenses can be fully deducted.
• If the profit forecast is negative, the income-related expenses must be apportioned and can only be 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. Expenses can only be deducted as income-related expenses in proportion to the paid part.

The Federal Fiscal Court has clarified that for the comparison calculation, "local rent" means the gross rent or warm rent. Consequently, the costs that may be passed on according to the Operating Costs Ordinance must be added to the comparable cold rent (BFH ruling of 10 May 2016, IX R 44/15).

The "local market rent" includes the cold rent plus the apportionable costs for flats of comparable type, location, and equipment.

The costs apportionable according to the Operating Costs Ordinance include, in particular, property tax, costs for water and sewage, heating, street cleaning and waste disposal, lighting, garden maintenance, chimney cleaning, property and liability insurance, and for the caretaker (§ 2 BetrKV). Maintenance and repair costs are not included according to § 1 BetrKV. Therefore, the warm rent paid is compared with the local warm rent (see also R 21.3 EStR).

The calculation method with warm rents is more advantageous for landlords than the calculation with cold rents, as it includes operating costs. These costs represent a significant part that the tenant usually fully bears even in the case of discounted rental.

The Federal Fiscal Court recently ruled that when renting furnished or partially furnished flats, a furniture surcharge is generally to be taken into account. Such rentals often come with increased utility, which is often reflected in higher local rents. However, such a furniture surcharge is only acceptable if it can be derived from a local rent index or realisable market surcharges. Other methods of determination are not permitted (BFH ruling of 6 February 2018, IX R 14/17).

Regarding the examination of the 50 or 66 percent threshold for the local rent, there is the question of whether to refer to the local rent index or the rent of a comparable, externally rented flat in the same building. The Thuringian Finance Court decided in October 2019 that the rent of a comparable externally rented flat in the same building should be used (ruling of 22 October 2019, 3 K 316/19). However, this ruling was appealed before the Federal Fiscal Court, and the landlord was successful.

The highest financial judges clarified that the local market rent for checking the 66 percent threshold should generally be determined based on the rent index. If no rent index is available or does not exist, the local market rent can be determined by expert opinions, information from a rent database, or by the comparative rents of at least three similar flats (BFH ruling of 22 February 2021, IX R 7/20).

Reduced-rate rental: Comparative calculation with apportionable service charges

Tax-saving model: rules for renting to relatives

Renting at a reduced rate to family members, particularly children, offers tax advantages: Although the rent is below market level, all expenses can be deducted as income-related expenses under certain conditions. This model is particularly suitable when high depreciation and interest on loans meet lower rental income. The arrangement is also recognised for tax purposes for dependent children.

Current regulations for reduced-rate rental

Since 01.01.2021, there are three tiers:

• At least 66% of the local rent:
  Income-related expenses are fully deductible – no forecast required.
• Between 50% and 66%:
  A positive total surplus forecast is necessary to deduct all income-related expenses. If the forecast is negative, expenses must be partially reduced.
• Less than 50%:
  The use is considered partially gratuitous. Income-related expenses are only partially deductible for the paid part.

Legal basis: § 21 para. 2 EStG

Arm's length comparison: Rental agreements with family members

Even when renting to dependent children, tax recognition is possible if the rental agreement withstands an arm's length comparison. This means:

• Legally validly concluded
• Clearly and unambiguously regulated
• Actually carried out as agreed

The BFH emphasises: “Strict requirements are placed on the proof of the seriousness of contractual arrangements between closely related persons”
(BFH ruling of 16.02.2016, IX R 28/15).

Example: If the rent is only offset against the maintenance claim and not actually paid, there is no paid rental relationship. In this case, the use of the apartment is considered maintenance in kind – income-related expenses are not deductible.

Tip: Pay cash maintenance and let the child transfer the rent themselves.

How is the local rent determined?

The basis is the local rent index. If there is a different rental for a comparable flat in the same building, the rent index still takes precedence. Only if no rent index is available or suitable can the local rent be determined alternatively – for example:

• through an expert report
• via rental databases
• or based on at least three comparable properties

BFH ruling of 22.02.2021, IX R 7/20

Generous properties: Total surplus forecast despite 66% limit

Even if the 66% limit is met, a total surplus forecast is mandatory when renting particularly large or elaborately designed properties.

Example:
Parents rent three villas (> 250 sqm) to their children. Losses of between 172.000 Euro and 216.000 Euro per year occur. The BFH does not recognise the losses – it is hobby as no intention to generate surplus was proven.
BFH ruling of 20.06.2023, IX R 17/21

Total surplus forecast for special properties

A 30-year forecast is required for:

• Living areas over 250 sqm
• Luxury fittings (e.g. swimming pool)
• High running costs

In similar cases, the BFH had already made it clear that the market rent for such properties does not reflect the actual living value. Therefore, it must also be checked whether the rental generates a surplus over the term (e.g. BFH rulings of 30.09.1997, IX R 80/94 and 06.10.2004, IX R 30/03).

Important:
The 66% rule only concerns objective remuneration.
The subjective intention to generate income can be additionally checked even if the limit is met.

Tax-saving model: rules for renting to relatives

What is included in income from renting and leasing?

What is included in income from renting and leasing (Form V) is regulated by the Income Tax Act. Section 21 of the Income Tax Act mentions the following types of income:

• Income from renting and leasing of immovable property (land, buildings, parts of buildings, ships registered in a shipping register)
• Income from renting and leasing of rights equivalent to land (e.g. hereditary building rights, mineral extraction rights)
• Income from renting and leasing of business assets, particularly movable business assets (e.g. business inventory for commercial enterprises, agricultural businesses or freelance practices)
• Income from the temporary transfer of rights, particularly literary, artistic and commercial copyrights
• Income from the sale of rental and lease payment claims

Not included as rental income are revenues from renting out individual movable assets. This applies, for example, to the rental of individual pieces of furniture, the chartering of boats not registered in a shipping register, or the temporary lending of private vehicles, for example for a holiday trip.

What is included in income from renting and leasing?

What applies to rental income from abroad?

As a rule, the foreign state in which the property is located has the right to tax the income from renting and leasing (taxation in the state of receipt). The foreign rental income is then tax-free in Germany but subject to the progression clause.

However, if the rental property is in an EU/EEA country, the rental income is not subject to the progression clause. Rental income from the EU/EEA does not need to be declared in the income tax return.

However, losses from renting out a foreign property in the EU/EEA cannot be claimed in the German tax return, even if they are not taken into account for tax purposes abroad (FG Baden-Württemberg, 08.07.2014, 4 K 1134/12).

Note: An important exception applies to properties in Spain. Rental income must be declared in Germany in the "V" form. The income tax paid in Spain on the rental income can be credited against German income tax.

Rental income from third countries (non-EU/EEA countries) is fully subject to the progression clause in Germany and must be declared in the AUS form. The foreign income must then be determined according to German tax regulations.

Be careful: Some double taxation agreements (e.g. with Switzerland) provide for the so-called credit method. In this case, the foreign rental income must be declared in the "V" form. The income tax paid abroad on the rental income can be credited against German income tax.

Therefore, each individual case of foreign property must be carefully examined to determine which state has the right to tax, whether the exemption or credit method applies, and whether the progression clause applies.

What applies to rental income from abroad?