(2023)
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.
