How is income arising from an investment in real estate taxed and can these taxes be reduced or offset in any way?
The income tax regime applicable depends on the legal status of the investor, on whether he operates, or is deemed to operate, a trade or business and on whether he has a permanent establishment in Germany.
Income from long-term lettings is, in principle, exempt from VAT, but an investor may opt to waive the VAT exemption in some circumstances. This is likely to be the case, for example, if input VAT has been paid on the cost of acquisition, or maintenance and repair costs, and the investor would otherwise be unable to recover it. However, one can only opt for VAT if the lessee is a taxable person for VAT purposes, leases the real estate for its business and does not itself carry out activities which might exclude a VAT deduction.
If an investor invests directly in German real estate, the applicable tax regime depends on whether the investor operates, or is deemed to operate, a trade or business. Only if the investor is deemed to operate a trade or business or actually operates a trade or business can he have a permanent establishment in Germany.
In the scenarios below the investor operates, or is deemed to operate, a trade or business:
If the investor is a corporate entity with a permanent establishment in Germany, profits generated by the permanent establishment, including income from letting real estate located in Germany, are subject to corporate income tax at the rate of 15% plus 5.5% solidarity surcharge thereon, resulting in an effective tax rate of 15.825%. Expenses incurred from letting real estate are deductible and reduce the taxable income. This includes administration costs, maintenance costs, real estate tax and amortization. Amortization only applies to buildings, including the cost of acquisition and related expenses (such as notary's fees, legal fees, experts' fees etc), but not to the land itself. The annual amortization rate for buildings varies between 2% and 3% of the acquisition or construction costs. In certain cases higher amortization rates apply.
Deductions can be claimed for interest subject to the 'interest cap rule'. Under the interest cap rule all interest expenses are, in general, fully deductible as business expenses in an amount equal to the interest income of the 'business unit' (Betrieb). If interest expenses in excess of interest income (net interest expenses) exceed €3,000,000, the deductibility of interest paid on debt will be limited to 30% of EBITDA (earnings before interest, taxes, depreciation and amortization). Exemptions from this interest cap rule may apply.
Trade tax rates depend on the municipality where the permanent establishment is located and generally range between 7% and 19.25%. Trade tax is not deductible against taxable income. However, in certain circumstances there is – upon application - a trade tax-exemption available for investors carrying on asset management only, ie their activities are limited to letting and management of real estate. Allowable corporate income tax deductions generally apply for trade tax purposes.
In relation to trade tax, to the extent – among other things – that 100 percent of all interest on debt payments (as far as interest payments have previously been deducted from taxable income) and 25 percent of expenditure on temporary usage rights (for example licences and concessions) exceed a threshold of €200,000, 25 percent of such amount must be added back into taxable income.
If an individual investor operates, or is deemed to operate, a trade or business he can have a permanent establishment in Germany. If the investor generates income through a permanent establishment (as defined by the applicable double tax treaty) in Germany, including income from letting real estate located in Germany, this is subject to income tax at the individual tax rate of the investor.
The income tax rate for individuals ranges from 14% to 42%. An additional tax bracket of 45% applies to taxable income in excess of around EUR 277,000 for individuals and around EUR 555,000 for married couples subject to joint taxation if the income qualifies as leasing income. An additional solidarity surcharge of 5.5% applies to taxable income of EUR 65,516 or more per year for individuals and EUR 131,032 for married couples. For allowable deductions and trade tax, see above on corporate investors. Income tax relief is available to compensate for the additional trade tax exposure. Repatriation from the permanent establishment to a foreign investor is not subject to additional income tax.
Individual investors may become subject to German trade tax which can – in some circumstances – be credited against personal income tax liability. Repatriation from the permanent establishment to a foreign investor is not subject to additional trade tax.
Direct investment without a permanent establishment
If the investor is a corporate entity generating income from letting real estate in Germany, this income is subject to corporate income tax at the rate of 15 percent (plus 5.5 percent solidarity surcharge thereon). Therefore, the rate of corporate income tax is effectively 15.825 percent of the taxable income.
German resident corporate investors are subject to trade tax but may (upon application) qualify for a special tax exemption if they are exclusively engaged in long term letting and management of real estate. In the absence of a permanent establishment in Germany no trade tax is payable by foreign corporate investors.
If the investor is an individual generating income through letting real estate in Germany, this income is subject to German income tax at the individual tax rate. The income tax rate for German investors is determined by their worldwide income. No trade tax is payable.
All profits generated worldwide by a German corporate entity are subject to 15 percent corporate income tax (plus 5.5 percent solidarity surcharge thereon), resulting in an effective corporation tax rate of 15.825 percent, and to trade tax of generally between 7 percent and 19.25 percent. For potential deductions and trade tax exemptions see above.
