Sale of properties held as private assets – Recognise and avoid the tax pitfalls
10-year holding period until you can sell a property tax-free
To calculate the requisite holding period, pursuant to Section 23(1) of the Income Tax Act (Einkommenssteuergesetz, EStG), it is solely the dates of the signing of the respective notarial purchase agreements for the acquisition and the sale of the property that are relevant, irrespective of the transfer of the physical possession of the property, the benefits and encumbrances (cf. rulings by the Federal Fiscal Court [Bundesfinanzhof, BFH] of 15.12.1993 and 8.4.2014; as well as the administrative opinion, cf. German Income Tax Guidelines, Guideline 23 (EStH, H23) bullet point related to holding period until you can sell a property tax-free [Veräußerungsfrist]). If there is a period of more than ten years between the respective notarial purchase agreements then the capital gain on privately held properties will be tax-free. Even if, in the meantime, a building has been constructed on a plot of land that was initially unbuilt then this would not constitute the commencement of a new 10-year period (cf. Section 23(1) sentence 1 no. 1 sentence 2 EStG). This is also the opinion of the fiscal administration that has issued the following example in this respect. “On 31.3.1993, ‘A’ purchased an unbuilt plot of land. In 1998, he completed the construction of a single-family house, which he subsequently rented out. As of the 1.4.2003 he has been able to sell the developed real property without the gain being subject to tax under Section 23 EStG“ (Federal Ministry of Finance circular of 5.10.2000, Federal Tax Gazette (BStBl) I 2000 p. 1383, margin no. 9).
Please note: German law-makers have moreover adopted an exception with respect to the taxation of private property sales, namely, if the property is admittedly sold within the 10-year period, but has been used exclusively for own residential purposes, or at least during the year in which the property was sold as well as in the two preceding years (Section 23(1) sentence 1 no. 1 sentence 3 EStG). In addition, you should bear in mind that the BFH has already decided on several occasions (inter alia ruling of 3.9.2019, case reference: IX R 10/19; decision of 3.8.2022, case reference: IX B 16/22) that ‘interim letting’ shortly before the sale would not be harmful for the application of this exemption provision. According to case law, it would be sufficient if there had been a consecutive period of self-use of one year and two days; in this case, the period of use for own residential purposes would have had to have stretched over the entire year that preceded the sale of the property so that there would have been self-use of the property in the second year prior to the sale on the last day, at least, and on the first day in the year in which the sale took place.
VAT aspects
Tax liability option in the case of rentals
Normally, pursuant to Section 4 no. 12a of the VAT Act (Umsatzsteuergesetz, UstG), the (long-term) renting out of property is exempt from VAT, so that input VAT may neither be deducted when the property is acquired nor during the production of a building. However, the situation is different where, in accordance with Section 9(1, 2) UStG, for example, commercial premises are rented out to other businesses and the VAT liability option has been selected. This gives the landlord the advantage of being able to deduct VAT on incoming supplies as input VAT. This will apply even if the property is held in private assets; this is because even if the asset management is not carried out as an independent activity, the renting out is regarded as a business activity within the meaning of the UStG. The same will also apply for the sale of a property, that under Section 4 no. 9a UStG, is admittedly generally tax-free, although here, too, under Section 9(1, 3) UStG it is possible to opt for VAT liability.
Transfer of a going concern
However, if you are intending to sell, you should first check to see if the transaction could be a non-taxable, so-called, transfer of a going concern (TOGC) pursuant to Section 1(1a) UStG. This could be the case if, for example, a single property is sold from among several rental properties, the acquirer continues the lease agreement and, in doing so, a separately run going concern is transferred. The conditions for this would thus not be satisfied if the vendor of the real property had already terminated its rental prior to the sale, or if the property is sold to the previous sole tenant. Moreover, a TOGC should not be assumed if a property development company transfers a real property. This is because, in such a case, the acquirer would not continue running the property development business, but would instead run a (new) letting company.
Please note: The reason why this is particularly important is because, in the case of a TOGC, given that there is no eligibility for taxation it would not be possible to opt for a tax liability under Section 9 UStG. Moreover, no input tax adjustment pursuant to Section 15a UStG will be triggered either because for the purchaser the adjustment period, described below, continues (‘footprint theory’, Section 15a(10) UStG).
Adjustment of the input tax deduction
If the transfer fails to qualify as a TOGC then you should bear in mind that the relevant circumstances within the meaning of Section 15a UStG could change and this could result in a considerable input tax adjustment. Here, the law also provides for an adjustment period of ten years (Section 15a(1) sentence 2 UStG). However, in this case, the adjustment period would only commence on the date when the asset is used for the first time (Section 15a(1) sentence 1 UStG). In this context, the date on which the input tax was actually deducted is also irrelevant.
Recommendations: The start of the 10-year period under income tax and under VAT can differ considerably from each other on account of the different reference points. That is why, if you are intending to sell, you should make a detailed assessment of the income tax and VAT consequences. In cases of doubt here, we would recommend getting tax advice and, where necessary, including the respective tax clauses in the notarial purchase agreement in the event that the legal opinion of the fiscal administration differs from that of the parties to the agreement.