(2023)
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.
