Living space is scarce and rents are rising. It is therefore common in some families to rent properties to relatives – at a friendly price. Perhaps you have already thought about this too. As a landlord, you then receive less income, but can nevertheless claim all expenses and depreciation. This gives you a tax advantage.
However, the devil is in the detail. If you are not careful, you may suffer a disadvantage. In this article, we explain what you should bear in mind if you want to rent your property to your parents, children, other close relatives or even acquaintances. You will learn what tax advantages you have and how to avoid disadvantages.
The Tax-Saving Model: Renting at a Friendly Price
A tenancy with a family member very often means that landlords waive part of the achievable rent. If you want to rent to a relative yourself, you will therefore generally reduce the net cold rent significantly. If handled correctly, this can even create a tax advantage. In a manner of speaking, you can make someone close to you happy while also saving taxes. But: There is a limit of 50 percent of the customary local comparative rent.
Note: It is irrelevant to whom you rent. It does not have to be a family member; the mechanisms also apply to tenancies between you and close acquaintances.
This Is How You Save Taxes
If you set a lower price than the customary local rent, you save taxes. Although you waive income, you can simultaneously claim the full expenses as income-related expenses and also use the depreciation in full. This applies subject to the proviso that you do not overdo it. The 50-percent rule is an important aspect that the tax office also examines.
To understand the tax advantage, it is useful to look at the taxation of rental income. As a landlord, income from real estate normally flows into your income tax return. At the same time, you can claim expenses such as parts of the operating costs that cannot be passed on to the tenants as income-related expenses. You also benefit from annual depreciation under AfA, in which Depending on the property, you can claim 2 to 2.5 percent of the value as a tax deduction for yourself.
If your income now decreases due to lower rental income, you have less to pay tax on. But that is not all. The trick is: You are still allowed to claim both the expenses and the depreciation in full.
The 50-percent rule
However, the tax office scrutinizes such “tax-saving models” involving relatives and acquaintances very closely. The Federal Fiscal Court decided in a ruling (10 May 2016, IX R 44/15) how high the rent may actually be. In that ruling, the court set the minimum at two-thirds of the local comparative rent. Anything below that would therefore be considered a hobby activity and would no longer justify the full deduction of expenses and depreciation.
In the meantime, this threshold has been lowered by law to 50 percent of the local comparative rent. In concrete terms, this means: If you charge an acquaintance or relative less than half the local comparative rent, the benefits no longer apply.
The rule is set out in the Income Tax Act (EStG). Section 21 (2) states:
“If the remuneration for allowing the use of a dwelling for residential purposes amounts to less than 50 percent of the customary local market rent, the use of the dwelling shall be divided into a remunerated and an unremunerated part.”
The percentage difference between the amount actually paid and the local comparative rent is the unremunerated portion. For this portion, you must reduce your expenses accordingly in your tax return. It is then no longer worthwhile to rent to relatives.
For amounts above this threshold, such a division is not required. However, there is still a gray area between 50 percent and 66 percent of the customary local comparative rent.
Only if you charge at least two-thirds of this amount as rent are you on the safe side. The following sentence in the same section of the EStG states:
“If, in the case of long-term residential letting, the remuneration amounts to at least 66 percent of the customary local rent, the residential letting shall be deemed to be remunerated.”
Caution: These thresholds always refer to the gross rent including utilities. According to a ruling by the Federal Fiscal Court, operating costs and heating costs are included in the assessment, provided these items are billed directly between the landlord and tenant.
Renting to Relatives and Acquaintances: the Various Scenarios
Several scenarios follow from the provisions of the Income Tax Act. After all, no one prohibits you from providing people with living space free of charge or at particularly favorable terms. However, the tax office may also take a closer look at rents amounting to, for example, 55 percent of the comparable rent. This gives rise to several typical cases.
- You do not charge any rent at all: Caution, you cannot claim any expenses in your income tax return. You may even face gift tax if the tax office regards the rent not charged as a gift under the Inheritance and Gift Tax Act (ErbStG, § 7) and the amount is sufficiently large.
- You charge less than 50 percent: In this case, you may offset at most the portion of the expenses corresponding to the proportion of the actual rent to the comparable rent.
- You charge between 50 and 66 percent: In this case, the tax office examines the property's profitability very closely. You may claim the expenses if, during this examination, the tax office determines that you have a long-term intention to generate profit.
- You charge at least 66 percent: In this case, there is no doubt. You may fully deduct your income-related expenses for the property and do not have to fear any disadvantages.
Special case: Maintenance obligation toward the tenant
If, as a landlord, you are subject to a maintenance obligation toward a relative, there is a special situation. If the rent waived forms part of the maintenance, the statutory threshold is reduced below 50 percent until the corresponding amount has been taken into account. You can therefore charge less than half without losing the tax benefit of full deductibility.
Furnishings count too!
Another special case is a furnished apartment. In such a case, the furniture is part of the rent. Therefore, the local comparable rent for unfurnished living space does not apply. Instead, properties with comparable furnishings are used for comparison. If these are unavailable, the tax office may deduct the provision of the furniture from the rent. This reduces the rent—possibly even below the 50-percent threshold.
How can the comparable rent be determined?
For the tax office, the local comparable rent is a decisive factor when assessing rentals to relatives and Familiar. But how is the local comparative rent calculated? There are various ways:
- Municipal rent index: Municipalities maintain a rent index. This is one way to estimate the rent. Disadvantage: The figures recorded there usually lag several years behind, meaning that the customary local comparative rent tends to be somewhat too low. If the municipality does not maintain a rent index, you can use one from a neighboring municipality.
- Determine three comparative values: You can determine the actual rent level based on three comparable properties in a similar location in the area. This is possible, among other things, via real estate portals such as traumimmo.de.
- Valuation: You can commission a real estate valuation. However, this method is costly, and you should only use it as a last resort in a dispute with the authorities.
In individual cases, the tax office may question the comparative rent. This particularly concerns calculations based on advertised comparable properties. Therefore, use current and comparable listings and archive the advertisements.
Protect yourself: Sign a rental agreement!
If you want to rent to relatives or acquaintances, you should always conclude a proper rental agreement. Firstly, this protects you against typical problems between tenants and landlords. These can also occur within even the closest family circle and may escalate particularly severely in such cases.
Secondly, it protects you vis-à-vis the tax office. You have proof of all the details of the rental arrangement and are much less vulnerable to challenge. You should take the following points into account:
- Conclude the agreement in writing and include all required details; avoid verbal side agreements.
- The net cold rent and operating costs must be clearly itemized. This protects your claims against the tenant and the tax office.
- Agree in the rental agreement or an additional document that the rent will be transferred, so that you have proof of the actual payments. Avoid accepting cash payments. In addition, the amount must not be returned to the tenant—even unofficially. That would be tax fraud.
- Bear in mind that you must rent out an apartment or house under regular conditions. You may not sublet your own living space. In addition, the tax benefits do not apply to usable areas such as garages that you rent to relatives or acquaintances rent.
- Prepare an annual statement of operating costs.
Renting to Relatives Saves Taxes
Whatever approach you take: Treat your relatives and acquaintances like a genuine tenant. This is the first step toward avoiding trouble with the tax office. In addition, set the rent high enough to eliminate room for interpretation and avoid grey areas. Then you combine a favor to a friend with a tax advantage.
If, on the other hand, you primarily want to provide financial support to someone close to you, there are many other ways to do so. It does not have to involve an unusually low rent for an apartment or house.