The rental of real estate leads to a taxation at the personal tax rate of the landlord. You can expect an income tax of up to about 50%. Therefore, in our article we examine the question of whether one can reduce the tax. More specifically, how can taxes on rental income be halved? The short answer to this is: by converting rental income into interest income. Interest income is subject to capital gains tax at a flat rate of 25%. The conversion of rental income into interest income takes place via a real estate sale to close relatives. The seller then hours the selling price, but receives interest. In this way, rental income can be optimized indirectly for tax purposes and asset succession can be tackled at the same time. On top: you also benefit from the increased property value.
Taxes apply when renting real estate. So far, we certainly agree with all readers of this article with our statement. However, we also say that this tax is twice as high as it should be. Would you like to defend this position? Hardly at all. Finally, rental income is subject to the regular personal tax rate, which is 42 % as a top tax rate and even 45 % as a wealth tax. If you add a solidarity surcharge and possibly a church tax, the share of rental income that flows into the Treasury’s coffers quickly climbs to a good 50%.
In fact, there are even more taxes. Although you usually pay no business tax, but the respective municipality in which the rented property is located, over the property tax. It also claims part of the rental income, with many landlords currently hardly able to estimate how high their property tax will be from 2025. And then you have to buy a property for rental. So you have to pay taxes right at the beginning of the adventure real estate rental: real estate acquisition tax.
So how dare we say that you basically pay twice as much tax as you actually need? Yes, you can suppose this little audacity to us. But if you want to ask us a really wise question about this introduction, it is this one alone: how can we now halve taxes on rental income?
In order to approach the answer to this really wise question – thank you for asking it, it shows your great foresight – we must first define the framework of our considerations. For our purposes, it should apply that we do not include a property acquisition tax or the property tax, but only discuss income taxes. If we demonstrate to you that you can halve income tax in terms of rental income, we have proven our claim.
Also without significance should remain the solidarity surcharge and the church tax. This is because they are calculated on the basis of the amount of the tax. You will see, for our design, with which we want to halve taxes on rental income, this has no impact on the overall result.
For this we need some basic knowledge of income tax law. Rental income – the specialist term is income from renting and leasing, or, as we tax lawyers shorten simplistic income from V & V – one counts as the so-called surplus income. The rental income is compared with advertising costs. Advertising costs include all expenses associated with obtaining rental income. In addition to the usual additional costs, which can be passed on to the tenants, this also includes those that only the landlords bear. For example, repairs or renovations. The levy you receive from the tenants, on the other hand, is part of the income.
In any case, this difference is the basis for taxation. Even if rental income should only be moderate in individual cases, it is often the case that landlords also earn other income, which then conditions the top tax rate as income overall. However, we want to clear our considerations of all these influences. Therefore, we are simply starting from the application of the top tax rate in the taxation of rental income.
So if we rent real estate, then we already own it. So we can also sell them. For example, we sell them to family members, preferably to our own children. Alternatively, we set up a family GbR or another partnership. Ideally, there is no real estate transfer tax when selling to certain related persons from the closest family circle. So let’s assume an example of a real estate sale by parents to their own children.
The purchase price should be realistic, but still as high as possible. Whether the children are actually sufficiently liquid to pay the purchase price is irrelevant. Yes, we even want the purchase price to remain unpaid, at least for the time being. Because in this way we can make a purchase price claim against the children. This purchase price demand can thus be regarded as a kind of loan. And for a loan, you usually get interest. It is precisely these interest rates that we have targeted in our design model.
Why are we interested in interest rates? First of all, interest rates have recently risen again, so that a return on the purchase price claim of about 5 % is realistic. In addition, this interest rate is all the more realistic, considering the fact that the parents complete the purchase price, because this is foreign usual. Thus, the financial administration has no reason to reject this aspect.
At the same time, one can currently assume a return on renting the property of approximately the same amount. So if we sell a property to our own children at a certain market value, then the children receive a return equal to the interest they have to pay their parents on their purchase price claim. Or in other words: If the parents had kept the property and rented it themselves, it would probably have achieved about the same return.
So what is the difference? The difference is that landlords pay almost 50% tax on rental income, but lenders have to pay only 25% capital gains taxes for the interest received. The question of how to halve taxes on rental income is thus answered: by converting rental income into interest income!
As much as this design benefits the seller of the property, in our example the parents, we must also note that the new landlord (the children) does not suffer any disadvantages. Ideally, they should also benefit from this design model. That's what we're thinking about.
In fact, interest costs paid, for example, to finance a real estate purchase are also advertising costs for the buyer. Because without this financing there would have been no real estate acquisition, ergo no rental income. In this respect alone, the buyer and current landlord does not incur any tax from the rental of the property, because the interest to be paid consumes the return completely.
The real advantage of the renting children, however, is that they will not pay any related gift or inheritance tax for the property acquisition that will take place anyway, whether by gift or inheritance. In this way, we also immediately optimized the asset succession for tax purposes.
Fine, the rental income, which had previously triggered a taxation of about 50%, we have converted into tax cheaper interest income. The whole thing has a catch, however, because the legislature has also considered whether the more favorable taxation of interest income among close persons should be allowed. Finally, this could lead to the more advantageous capital gains tax resulting in misuse of design by agreement between related parties.
Therefore, with regard to the taxation of capital gains (regulated by § 20 EStG) in § 32d paragraph 2 EStG, the legislature has additionally provided that the flat-rate capital gains tax does not apply to related parties. The obvious legal consequence of this regulation is that the landlord can purchase the property and can also set the interest costs in full as advertising costs in his income tax, but the seller must tax 25 % of his interest income at his personal tax rate instead of the taxation by capital gains tax. And this is about 50%, as we initially assumed. Therefore, there is no tax advantage under these conditions.
So have we promised too much? Not at all! For example, if parents sell their children real estate in the manner described above and receive interest income first, then this corresponds to a process that is also common with all other categories of people in question. So why should relatives be treated adversely in this regard?
A few years ago, a taxpayer turned to the Bundesfinanzhof (BFH), because the tax office adhered to the provision of § 32d paragraph 2 EStG and had taxed exactly this type of interest income at the taxpayer's personal tax rate. In fact, BFH did not see any legal basis to deny the taxpayer the more favourable taxation by capital gains tax in this context (BFH judgment of 29 April 2014, VIII R 35/13). Finally, the differential taxation is hardly compatible with the principle of equality guaranteed in the Basic Law.
Goal achieved: we have shown how to halve taxes on rental income. But whether the presented model can be applied in general is another question. Because this depends on many factors. On the one hand, you have to look at whether a yield of 5% can actually be achieved in the respective location in which the property is located. Accordingly, the amount of interest should also be adjusted in each case. However, this is only possible within a certain framework. This is because the arm's length principle applies. Only if credit institutions grant loans on comparable terms, such an approach seems acceptable in the relationship between the related parties. At present, however, these conditions do exist.
This article does not replace tax or legal advice in an individual case. Facts, current law, jurisdiction, documentation and implementation remain decisive.