Property acquisitions - Immediate deduction of upkeep expenses or recognition of acquisition-related production costs?
During periods when interest rates were at historically low levels, properties were frequently bought to let and, moreover, extensive building works were carried out. Such investments are not just essential in order to enhance living comfort, but also to create more environmentally friendly alternatives. For tax purposes, the so-called acquisition-related production costs play a decisive role within the framework of the acquisition transaction.
Distinction between upkeep expenses and acquisition-related production costs
With respect to the tax implications, it is important to distinguish between upkeep expenses and acquisition-related production costs. Even though both cases refer to builders’ and tradesmen’s services, nevertheless the income tax consequences are very different.
Upkeep expenses are incurred for property maintenance and repair. This also includes expenses for the renovation of already existing facilities. For example, costs relating to the replacement of a heating system constitute allowable expenses that are immediately deductible in the context of income from letting and leasing.
If, however such upkeep expenses are incurred within three years of acquiring the building then the issue of acquisition-related production costs comes into play. If the sum of the net expenses for maintenance and modernisation measures that are incurred during this period exceeds 15% of the acquisition costs for the building then, for tax purposes, the expenses will be regarded as production costs. Ultimately, the allowable costs that were deducted will then be recharacterised as acquisition costs.
Tax treatment and consequences
The assessment of these costs for tax purposes is very different. The upkeep expenses may be claimed as an immediate deduction of allowable costs in the assessment year in which the payment outflows occurred. The entire payment amount has the effect of reducing the tax liability.
In the case of acquisition costs or acquisition-related production costs, the deduction of allowable costs takes place solely via depreciation. For income from letting and leasing, 2% or 3% of the acquisition costs normally have an impact on the taxpayer’s income.
Moreover, the tax burden that results when tax assessment notices are corrected retrospectively should not be underestimated. The recharacterisation means that the deduction of allowable costs will not be permitted, whereby the income in the year when the payments were made goes up. The increase in the depreciable basis leads to an increase in the depreciation amounts, which is why the income is only partially reduced. Since not allowing the deduction of upkeep expenses is only compensated to some extent, this usually results in a retrospective tax liability. To change the respective tax assessment notices the fiscal administration may apply a separate regulation for making amendments.
Practical example
In 2020, a private individual purchases a building at an acquisition cost of €1,000,000. The limit for the assessment of the acquisition-related production costs would therefore be €150,000 (15% of €1,000,000). From 2021 to 2023, the expenditure incurred each year for the modernisation is €100,000 (net).
Property acquisition:
Acquisition cost of €1,000,000
First 3 years after acquisition:
Limit of €150,000 (15% of €1,000,000) for valuation
For 2021, a tax return is submitted together with Appendix V (for rental income) with the upkeep expenses. In the tax return for the following year, the upkeep expenses already add up to €200,000 and thus exceed the upper limit. Subsequently, the 2021 income tax assessment notice is retrospectively amended with regard to the allowable costs. In both assessments only the deduction of depreciation on the increased depreciable basis is still permitted. The approach whereby costs are immediately deductible does not apply.
