Transcription
The process becomes even more interesting when it's difficult to directly finance real estate abroad. It's difficult for a German citizen to finance a property with the security of a foreign property. However, what is certainly possible is if, for example, I own a German property, mortgage it, take out a loan, and then use the purchase price to actually pay for the property in Zanzibar. Then there's a direct link between taking out the loan and paying for the property in Zanzibar, and I should be able to claim the loan interest as a tax deduction.
"Perspective Abroad," the podcast for entrepreneurs and freelancers who are drawn to working abroad. Whether it's tax planning, setting up a foreign company, or lifestyle questions, we get down to business every week. And here are your hosts: Daniel Taborek and Sebastian Sauerborn.
Yes, we're delighted to welcome Ronny Walch to our channel today. Ronny and I were together in Fumba Town, Tanzania, and we had hours of conversations with many of our clients, some of whom are also your clients, or perhaps many of the viewers and listeners watching this video will become clients now. The question that kept coming up was how rental income works. If I receive rental income, whether in Zanzibar, Dubai, Georgia, or Serbia, I pay ten percent in Tanzania, but what happens in Germany? And we're incredibly happy, Ronny, that you can help our clients in Germany with this and shed some light on the subject – what happens and how can the tax structuring of rental income be optimized?
Before we go into detail, Ronny, please briefly introduce yourself to our viewers and listeners.
Yes, with pleasure, Daniel. Yes, Ronny Walch, I'm a tax advisor and managing director of TAXVANTAGE Steuerberatungsgesellschaft (tax consulting firm) in Magdeburg. We are a team of approximately 25 employees, advising clients in the traditional areas, and we also have TAXVANTAGE Consulting attached to our services – this is where we delve into specialized consulting, typically focusing on corporate structures, setting up holding companies, and even establishing Liechtenstein foundations. But, well, you know yourself, when you talk about wealth and wealth protection, real estate always comes up, and increasingly, foreign real estate as well – how do you structure it, how do you plan it, perhaps even to avoid inheritance tax? These are the kinds of topics we deal with. What's perhaps a bit special about us is that everything I talk about, I don't just talk about, I live it. I myself have a Liechtenstein family foundation, and we own real estate in Liechtenstein. And, as is no secret, we are currently in the process of becoming part of the Fumba family. And I think that's what sets us apart: that we don't just learn from books, but that we live what we advise and advise our clients.
Great. So, let's get into the topic now.
Gladly. So, it's a recurring request from our clients, because, as I've already mentioned, some of them say, "I want to move to Fumba Town completely." Generally speaking, leaving Fumba Town aside for now, there are clients who say, "I'm buying real estate abroad as a backup." That could just as easily be in Dubai, or anywhere in the world, in other countries. We were in Georgia again last week with eight clients. So, I'm buying a property abroad, but I don't want to live there 12 months a year—it's my backup property, which I want to rent out for several months. And now we're talking about the rental income, and the question is, what happens to the rental income? Let's take the classic case in Zanzibar again. In Zanzibar, for example, in Tanzania, I pay ten percent of my rental income in taxes. So, what happens now, that's always the question, with the rental income in Germany? And many of our clients have seen some rather adventurous YouTube videos about this – well, anyway… They say, well, you could set up a US LLC, and then the US LLC would simply buy the property, and then nobody would notice. From our perspective, that's the wrong approach, and you 'll probably agree—from your perspective, the wrong approach, one we would never recommend. But what else can we recommend? That's what this video is about.
Exactly. So, perhaps we should start by putting things into perspective. Basically, if you have a natural person who is resident or habitually resident in Germany, then they are subject to unlimited tax liability. This means, in principle, on their worldwide income. This would also include rental income in, let's take Tanzania as an example. In principle, this would always lead to double taxation because, as you just mentioned, Tanzania has a 10% tax rate, Germany would also tax it, and then there are regulations and avoidance provisions. The first thing typically checked is the double taxation agreement – unfortunately, we don't have one with Tanzania here – because a double taxation agreement would essentially assign the right to tax to the respective country, which is typically always the country where the property is located, so in this case, Tanzania. Then, in Germany, there's always the option of either crediting the foreign tax, the so-called tax credit procedure, or it's subject to the progression clause, meaning the other German income is taxed at a slightly higher rate. If we don't have a double taxation agreement, then the so-called unilateral provisions apply. This is typically Section 34c of the Income Tax Act, and then the foreign tax is credited. So, that's the basic overview.
So, well, if all income is taxable in Germany, then we have to say that it's generally considered German law, and therefore we have to classify the income someone earns into one of seven income categories – typically rental or leasing. And there's a very interesting aspect here, which we see very, very often in the German context, but which I think can also be applied to real estate in Tanzania: the concept of "hobby." What does that mean? It means that, in principle, for an income to be taxed in Germany, there has to be a so-called profit motive. And that's a very interesting aspect. Why? If I use the property myself for a large part of the year and therefore only generate low rental income, then it can sometimes be the case that, when I look at the ratio of income to expenses, I have to fly over at least once a year or every six months to check the condition of the property and arrange for repairs. Unfortunately, we also know that when you rent out properties, especially short-term rentals, things break down and need to be repaired. During construction, there are always certain things that need to be checked, and perhaps during the construction phase, I need to go over and inspect everything from time to time. This means that it's quite possible to incur very high losses in the initial phase, which I can't offset over a certain period. And then it's always the case that the German tax office says, well, if I can't provide a total surplus forecast, meaning that I truly have this profit motive, then these earnings aren't taxable in Germany at all. This applies to both German and, of course, foreign properties. And that was the point where I said, Daniel, well, if you have someone who uses the property themselves for a large part of the year, including during the best times, typically over the winter when it's cold in Germany, spends the winter in Zanzibar, and only rents the property out for a few days a year... If you're renting out a property, you should check whether this total surplus forecast might classify it as a hobby and whether you don't even have to declare it to the German tax office. The legal consequence is that you don't have to declare the income you generate to the tax office at all. In other words, it's not reportable because you're not participating in any tax system...
Let's rewind a bit for those who found that a little too much tax jargon. But first of all, thank you very much, excellent explanation. Someone is buying a property in Dubai, Zanzibar, or Georgia. I now own this property. At what point does my income trigger a tax liability, essentially, when I start renting out this property?
One of the typical tax advisor answers: It depends. Even though I never like that answer. But let's look at an example. Let's assume we actually have 120 days of rental potential per year. That's also a very important point. Thankfully, the Federal Fiscal Court's (BFH) case law is relatively clear on this point. This means the relevant period is the time the property is actually available for rent. I can typically prove this using a booking calendar or similar tool. This period truly counts as the time of expenditure. So, for this period, I can calculate depreciation on a notional basis, and for this period, if I'm financing it with a loan, I can include financing costs, a pro-rata share of property taxes in the respective country, cleaning costs, and so on – basically everything that arises in such a property. That means if I have the rental potential for 120 days, but only rent it out for, say, 30 days because it might not be the best time of year, then I really only need to consider whether the rental income from those 30 days will cover the costs for the entire 120 days. This includes, especially if we're talking about flying from Germany, for example, a trip to Zanzibar, which might cost €2,000 or €2,500 round trip, and these expenses can be factored in as advertising costs when checking on the property. Are those 30 days' rental income sufficient to cover the costs for the 120 days the property is potentially available for rent? And if the answer is no, which is quite likely given the flight costs and other expenses, then I'm not making a profit because my expenses exceed my income, and therefore I'm not triggering any tax liability. So, to answer your question, if the rental income is higher than the expenses I incur, then I immediately trigger a tax liability. And this can be for a period of up to 30 years, a total surplus forecast. That means if, during the construction phase, I say, "Well, I want to keep an eye on things," then the kitchen is installed, then I might need to be there when the foundation is poured, then I'll inspect it when the shell is up, and so on, because typically your clients buy off-plan, meaning they buy before the construction phase and oversee it. Then it can happen that losses of 20,000 or 30,000 euros, perhaps, arise with very intensive management, and these then need to be offset over the next few years. If this total surplus forecast is negative, then I don't trigger any tax liability in Germany.
Okay. Now, to summarize... Let's assume someone buys an apartment now, for example, in the Soul development, specifically in Fumba Town, for €100,000. With this apartment, they could potentially generate a 10 to 15 percent return through short-term rentals – that 's the current possibility. They'll receive the apartment; in this case, the first units will be handed over in six months, so let's assume they could start generating rental income next year, in 2026. Let's take the scenario where they... He just paid €100,000 for the apartment and now has €5,000 in rental income, for example. Next year, he'll have €5,000 in travel expenses. So, what happens now? You're the tax advisor at the end of the year. So, I have €5,000 in rental income and €5,000 in travel expenses – what do you do now as a tax advisor?
Let's assume the case is like this: we're not using it ourselves – I understood you to mean it's for renting out – then, basically, if I have a purchase price for a property, I have to allocate it. Let's correct myself. I was there myself for a month. Okay. It's always nice when a case develops dynamically. Exactly. Okay. But no problem, that's how it is in practice with clients. Basically, I have to allocate the $100,000 between the land and the building. I don't need to do that in this case because the building is leased on land, meaning the $100,000 (euros in this case) is actually for the building itself. This means that German depreciation regulations generally apply. It's a new building, so currently we're at three percent. An important point to note, because there are a lot of videos on YouTube right now about declining-balance depreciation, special depreciation, and all the other great options available, doesn't apply to Tanzania because Section 7b, the special depreciation allowance, only applies within the EU, and declining-balance depreciation only applies within the EU, and I mean the EEA – we're not in either of those countries. So, we would have the standard three percent depreciation. $100,000 is easy to calculate, which is €3,000 in depreciation. Then we had €5,000 in travel expenses, maintenance costs, and so on, meaning we have €8,000 in total costs. And now comes the special case. Since you mentioned using the property yourself for a month, I'd have to multiply my incurred costs by 11/12. 8 11/12 – I can't quite do that in my head right now, but it should be around €7,000-something in expenses, and I'd only have €5,000 in rental income. That means I'd actually incur a loss that year, and the tax office would consider that a hobby. So, I wouldn't have to declare it on my taxes.
And the process gets even more interesting, even though it 's difficult to finance real estate abroad directly. It's difficult for a German to finance a property with the security of a foreign property. However, what is quite possible is if, for example, I own a German property, take out a loan against it, and then use the proceeds to pay for the property in Zanzibar. Then there's a direct link between taking out the loan and paying for the property in Zanzibar, and I could also claim the loan interest. Let's assume that's even more than that—that was n't the case in your example, but I just want to illustrate how much one should realistically expect in costs. Could I do the following—this is another interesting point—let's say a married couple buys something. Couldn't the husband say, " I'll borrow the money from my wife"?
Exactly. So, if the couple were to buy, that would only work to 50 percent, because in Germany it's illegal to essentially conduct credit transactions with oneself. So, in effect, the wife would pay for it herself, and the husband would borrow it. But if we don't slightly modify the scenario… The husband says, "I'll buy it now, and my wife will lend me the money"—that would work, and that would incur additional costs. So, my wife would then calculate the market-standard interest rate, for example. Please, no exorbitant interest rates, so please no 12, 13, or 14 percent, but I can actually see rates in the 7 or 8 percent range, depending on what collateral the man provides. Why? Because I can't take out a traditional mortgage, since the bank always has a... A mortgage is used for valuation purposes, and if the man doesn't use the single-family home as collateral but instead says, "Hey, I'll take the $100,000 as a purely consumer loan," then the interest rate is significantly higher than in real estate financing. So, I would currently consider 7 or 8 percent to be standard and compliant with market rates. That would amount to another 7,000 to 8,000 euros or dollars, depending on the rate, in interest expenses, which I would then allocate 11/12 of (one month's private use – it's important to note that this is the allocation). And in most cases, even if the return on investment is 10 to 15 percent, if I factor that in, I very quickly end up in the loss zone for tax purposes, thus classifying it as a hobby. This means I don't even have to declare the income or the relevant tax base to the tax authorities.
And that's my question again, dear Ronny: who can decide that I don't have to declare the income? So, you, as my tax advisor, make that decision. If I live in Germany and say, "I'm here with Ronny, my tax advisor, look, here are all my incomes, here are all my expenses," and you would say, "My dear client, I've looked at this. You've mentioned income from your property in Zanzibar, Dubai, or Georgia, or wherever, and I've also seen your expenses. We don't have to declare this income, and therefore these expenses, in your tax return." Is that correct?
Exactly, that would be one possibility. It's one way to consult a tax advisor and have them certify it. I would, of course, ask the client to break down the anticipated rental income and the anticipated expenses for me. Should we end up with a combined loss, then it wouldn't be a problem to write to the tax office, "Dear client, I don't see any intention to generate income here; therefore, this isn't a case that falls under renting or leasing, and you don't have to declare it." However, it's always important to note that if anything changes—for example, if loan interest payments cease, travel expenses disappear, or rents rise dramatically (we're all hoping for great value development in Fumba, both in terms of property prices and rents)—then this could indeed change. That means I should review this regularly, at least every three or five years, to check whether I'm still in the red in the overall profit forecast.
Now, another question: Is it possible, and I'm being very cautious here, to provoke the tax office into classifying your property as a hobby? That means I first try to declare a loss on my tax return, and then the tax office decides, "We don't accept this as an investment property," and what happens in the following years?
So, you don't even have to provoke them; it's more or less automatic. If I have a property that generates losses, I'll generally receive a tax assessment with a provisional note. This means the tax office determines and says, "Dear taxpayer, you declared income according to Section 21, i.e., rental and leasing, and it's negative. We'll certify this for now because a loss also means I pay less tax on my other income, typically as a freelancer, employee, or business owner." And of course, the tax authorities don't want that. So, they initially acknowledge it but add the provisional note and typically monitor the situation over the next few years. How things develop... And as a rule, after three years, or at the latest after five years, if there are consistent losses, the tax office will come forward and say, "We see this as a hobby." The tax office doesn't even have to prove this; they can initially say, without further evidence, that it's a hobby, because the burden of proof lies with the taxpayer. That's always a very interesting fact. We have the same thing with German real estate. We remember how high property prices were in the late 2010s, and even in 2020, during the pandemic. Holiday homes on the Baltic Sea, which are very popular, often run at a loss due to high purchase prices, depreciation, and financing costs. Clients then say, "What am I going to do now? The tax office is going to disallow this property!" To which I say, "We have two options: either we prepare a total surplus forecast and demonstrate to the tax office that we will be profitable over the long term, for example, because interest payments on the mortgage will decrease and thus increase profits; or, dear client, we accept the tax office's assessment." Typically, I then contact the tax office again and say, "Okay, dear tax office, we understand. You now see this as a hobby business. Please confirm this for us because we will no longer declare this income in future years, period." And if I don't change the basic business model, then that's fine too. Of course, you can't just start advertising like crazy, increasing rental periods, tripling rents, and so on. I'm warning you not to say, "Hey, I'll scale things back once I get the green light from the tax office, then ramp it up"—please don't do that either. But that 's the typical approach, exactly. You can certainly try claiming the losses on your income tax return first. It will generally lead to the same result, and that's where I say, if I already know I'm making losses, why should I hire a tax advisor to calculate the income and pay them? Because, of course, we don't get our invoice back, since the work is done if it's clear beforehand that we won't have any positive results.
Interesting. Something to watch out for, just a quick side note: We have reporting obligations for foreign properties via CRS and AIA, which are supposed to be implemented soon. That means, please don't be alarmed, the probability is very, very high that if I own a property and the tax office comes along in three, four, or five years and says, "Wait a minute, you have a property abroad, what about this property?" And it's very, very good if you can then say, "Hey, dear tax office, look here, I had a tax advisor review it three years ago, and received a letter stating that it's a hobby because it's not profitable," and then intervene, then you should generally have peace of mind. Then they can perhaps follow up, "Hey, what's the current situation? Has it changed?" In my view, that's the quickest way to ensure peace of mind, because if the tax office approaches you and says, "Hey, we suspect that income isn't being declared," the situation is never in a good position. That means you can certainly consider proactively approaching the tax office and saying, "Look, I bought a property here that I use mostly for private purposes. What I rent out—I've done the math, and it's not profitable. I wouldn't declare it as a hobby." Would you do something like that for your clients, for example? If someone is a client of yours, would you say, "Come on, this is your property now, let's draft a letter, send it there, and try— that's what I meant earlier by provoking them—let's speed up the process?"
The tax office makes the decisions about whether something is a hobby. That's not a decision in itself. They are bound by law; if there's no intention to generate income, it's not a taxable activity. So, if I give the tax office a negative forecast, they have absolutely no discretion. They can't say, "Well, you should declare it" or "report it," because it's not reportable by default.
An interesting point. Now, there's another scenario where someone might say, " I'd like the owner of this property to be a foundation." Now, we have the case—which we briefly mentioned in our preliminary discussion—where, currently (this may be different in other countries, but in Zanzibar/Tanzania), I, as a natural person, must be the owner to obtain the Golden Visa. That means we have a scenario where I could register both my foundation company, for example, as the owner, and myself personally as an additional owner to obtain the Golden Visa for the family. So, a classic scenario would be: the owner is a family member, for example, the husband or wife, and then the foundation is also listed, and the husband can then apply for the Golden Visa for the whole family – only one person needs to be registered as the owner. Could you briefly explain this scenario again from a tax perspective for our viewers and listeners?
So, in your earlier example, it will probably be quite difficult with a €100,000 property, because I need the €100,000 to get the visa, but there are also very, very nice properties in Fumba that are more expensive, but of course also better located, and even include beautiful villas. Very briefly, and very briefly from the perspective of the land registry, the ZIPA authority, if you register two owners, a company and a natural person, simultaneously, then from the land registry's point of view, both are considered 100% owners. That means each owns 100%. So that would work.
Okay. So that means I don't have to worry about the value? This only concerns the land registry. So that means I don't have to worry about the value, that I actually pay the $100,000?
You can do that. You can do that in Zanzibar. You can say they aren't both equal, full owners, but you can say 50/50, 90/10, whatever, that works. It's basically the same as if you were to register, for example, a brother and a sister, you can do that, two siblings. Then either the brother and his whole family have the option of getting the Golden Visa, or the sister, even with $100,000. So, in this case, assuming we're talking about a foundation, we need to look at where the foundation is located. If it's a German foundation, same issue, subject to unlimited corporate tax liability, then that probably won't help much. If we're talking about a foundation abroad, let's take a classic example, a Liechtenstein foundation, a foundation within the EU or, in this case, the EEA, then it's actually the case that if the foundation isn't subject to unlimited tax liability in Germany—meaning the foundation board isn't based in Germany and the assets are effectively removed from the founder's control—then this foundation wouldn't be subject to taxation in Germany. Then, for example, a very attractive arrangement would be to share the property, let's say it's worth €100,000, and let's say I use the property myself for two months of the year and rent it out for ten months. So, for example, one could draw up a partnership agreement between the individual and the foundation stipulating that the purchase price will be divided as follows: 2/12 for the individual and 10/12 for the foundation, with the individual paying their 2/12 share to use the property themselves. So, that means... Let's take, for example, what if I were to do it this way: I only pay for my exclusively private use, so I don't generate any income, I have no intention of generating income, and therefore I don't attract any attention from the tax authorities at all. It's still possible, though, that they might inquire and say, "Hey, you have a stake in a property abroad, what's the deal with that?" And if I say, "Well, I don't rent it out, I don't generate any rental income, and besides, it's for my own use," then that's the end of it. And the other 10/12, which the foundation essentially pays, would then be the rental income portion. That means the foundation would generate the rental income, which would then be taxable in Zanzibar, Tanzania (which is part of the portfolio), also at the respective 10% rate. However, the income wouldn't be taxed again in Liechtenstein within the foundation. And so, I would essentially have the perfect model for getting foreign income into the foundation in a tax-optimized way and then taxing it at only 10%. The question is always whether a Liechtenstein foundation is worthwhile for real estate. That's certainly debatable, but typically we have investors who also own real estate in other countries, or as I've seen with you, they buy another three or four properties. In such cases, this structure can definitely be worthwhile because it legally shields the investment from German taxation.
But would something like this also work with, for example, a Swiss association?
With Swiss associations, we need to look at how it 's regulated under the Foreign Tax Act. And there, let's stick with the topic of foundations for now. There are foundations in other countries, and one problem, for example, is in Section 15 Paragraph 1 of the Foreign Tax Act: the family foundation is always allocated proportionally to the founder, the beneficiary. If I have three beneficiaries, each is allocated one-third. The exception clause only applies if I have a foundation there that would be valid in another EU or EEA country (Switzerland is neither EU nor EEA). In principle, we would at least have that if the Swiss association were to grant the beneficiary – I'm not familiar enough with the Swiss association to say for sure – but if the beneficiary were a German citizen, that could actually…
Interesting, isn't it?
Absolutely, definitely. So, as always, it depends; it's always a case-by-case analysis and what's worthwhile, especially considering the client's existing structure. But if there's a division of assets, it's different than if someone says, "I have a holiday property," which I think is your classic scenario. "Well, I can rent it out for a few months," then you can certainly achieve a subsidy for the property. So, it's an interesting topic, and a bit complex too.
If one of our clients has another question and wants to discuss it with you, what's the best way to reach you?
Well, either directly through our website, www.taxvantage.de – there's an option to schedule an appointment there – or, as you can see, I'm not your typical tax advisor in a suit and tie. So, feel free to connect with me on LinkedIn, send me a message, and I think we can have a very good exchange of ideas there. But as I said, it always comes down to individual consultation. That's what sets us apart as a firm – we're not the ones who hold big seminars and say, "This is how it can work," and then leave the client to figure it out on their own. Ideally, we create a tailor-made solution and say, "Okay, let's look at the overall situation, what existing structures are there, what can we utilize, and what makes sense in terms of cost?" The general rule is that if someone buys a $100,000 property in Fumba Town now, the purpose of a Liechtenstein foundation will not be proportionate to the expenses. I agree with you.
Then all I can say is thank you so much, Ronny. I look forward to seeing you again soon, whether in Fumba Town, Georgia, Serbia, Dubai, wherever – there are always opportunities – or Zurich. In any case, thank you very much for your information today for our clients. Stay cheerful.
You're very welcome.
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