The definition of the intention to generate income
In a circular of 8.10.2004, published by the Federal Ministry of Finance (Bundesministerium der Finanzen, BMF), the fiscal administration detailed the preconditions for rental income to be recognised for tax purposes: primarily there has to be the intention to generate sustainable surpluses in the long term. According to the established case law of the BFH, this can generally be assumed where property is rented out on a permanent basis. Permanent renting will always be presumed when the rental contract is not time limited.
Evidence that contradicts the presumption
However, the standard assumption of an intention to generate income merely constitutes a presumption. The objective burden of proof lies with the landlord. Special circumstances or types of use could provide arguments against an intention to generate income.
- Charging below-market rent – e.g. to close relatives – would in principle be an argument against an intention to generate income if the rent excluding utilities plus service charges is not at least 66% of the average market rent for the local area.
- If holiday homes are rented out exclusively to alter-nating holidaymakers, then it would generally be assumed that there is an intention to generate surpluses. The situation would however be different if the home is also used by the owner(s) to some extent.
- Furthermore, doubts would be cast on the intention to generate income if there is solely temporary renting with losses via rent-to-own schemes (Mietkauf) or builder-owner models, an option to sell the rental property within the first loss-making period, as well as the sale of a rental property within five years after the date of purchase without having generated rental revenue surpluses.
If there is evidence that contradicts the intention to generate income then such cases will be reviewed by the fiscal administration. In the context of a review, the tax office normally requests a total surplus forecast from the landlord.
Total surplus forecast
Particular cooperation will be required from the landlord when the local tax office casts doubt on the total surplus for a rental property. This would normally apply in the case of renting out for residential purposes if the contractual rent is between 50 and 66% of the average market rent for the local area. On the basis of a forecast calculation, the landlord would have to determine if and in what amount and from which year a total surplus can be generated for the respective property. In doing so, all the income and expenses (including depreciation) that can be expected will need to be included. As a general rule, the forecast period begins with the acquisition or production of the property. The time span needs to be based on the expected useful life of the property. In the case of an unlimited rental contract this would encompass 30 years. For time-limited rental contracts this period would be shortened accordingly to the period laid down in the rental agreement. All objectively discernible circumstances and foreseeable future factors need to be taken into consideration. If the result of this total surplus forecast turns out to be positive for the forecast period, then it can be assumed that there is an intention to generate income and the rental income will be taken into account within the scope of the income tax assessment. If it is not possible to anticipate that a total surplus will be generated then this would constitute a situation of Liebhaberei. Consequently, neither the rental income nor the allowable expenses may be included in the income tax assessment.
If, over time, there is however a change in the circumstances that would imply that there is an intention to generate income then the rental income would once again need to be specified in the income tax return.
An exception - Renting out luxury property
An exception to the above-mentioned principles occurs for the renting out of so-called luxury properties. In the view of the BFH, in its ruling of 20.6.2023 (case reference: IX R 17/21), in the case of rental properties with a living area of more than 250 m², which moreover have been especially elaborately designed or fitted out, particular requirements have to be laid down for the proof of the intention to generate income. When luxury properties are rented out a total surplus forecast always has to be provided even if the rent that has been received is more than 66% of the average market rent for the local area.
The reason that the BFH gave for this was that it was not possible for the achievable market rent to adequately reflect the specific desirability value of such properties. Moreover, in view of the costs of such properties, it is frequently not even possible to cover the costs by renting them out. Ultimately, in such cases, the practical consequence of the ruling will be a two-step review:
1st step:
Determination of the remuneration rate of the market rent in relation to the average market rent for the local area.
2nd step:
Liebhaberei test on presentation of the total surplus forecast including the eligible income and allowable expenses in accordance with the remuneration rate under the 1st test step, so that in the event that the 66% rate is exceeded a Liebhaberei test will need to be carried out on presentation of the total surplus forecast.
Conclusion: In this decision the BFH confirmed its earlier ruling and substantiated it to some extent. Aside from the appropriateness of rented-out luxury properties as investment properties, for other reasons this asset class has not gained in attractiveness as a result of the above-mentioned ruling - from a tax perspective at any rate.