For rental properties, rentals represent taxable income. With a clever design, however, you can achieve that landlords can collect their rental income tax-free. This applies a model in which the purchase of the property is externally financed by a Immobilien-GmbH. First, you take out a loan from a bank. This loan should cover about 80 % of the acquisition costs. The interest rate is expected to be 1%. In order to cover the default of the loan in the event of insolvency, the lending bank is entered in the land register, where it is the sole creditor.

However, in order to finance the remaining 20% of the acquisition costs, the buyer of the property takes out a loan from an affiliated company. Since this loan does not receive coverage of the land debt, one expects a significantly higher interest rate. The risk of loss of the loan in the event of insolvency is therefore high and thus justifies this high interest rate. Otherwise, the otherwise unusually high interest rates would be considered a hidden profit distribution (vGA). Together with the depreciation, the interest now depresses the profit so that in the end, at most, a small amount is subject to taxation. In this way, the rental income can be collected tax-free.

Rental income on rental properties is of course taxable. You can offset the rental income with expenses that are related to the rental. In addition to repair and maintenance costs, this also includes expenses associated with financing the purchase of the property and, of course, depreciation. If you now want to collect rental income tax-free, then this already succeeds with these funds. How exactly, we demonstrate this to you in this article.

First of all, we want to assume that we intend to purchase the property through a Immobilien-GmbH. Furthermore, this real estate GmbH is to be a subsidiary of a parent company (for example a holding company). As a purchase price, we assume a fictitious amount of EUR 10,000,000. The annually expected rental income can be considered realistic with EUR 500,000. And we now want to collect this rental income tax-free.

In order to finance this purchase, Immobilien-GmbH contacts a credit institution in a first step. In fact, you can assume that you get a loan that covers 80% of the purchase price. In return, you have to expect an interest rate of 1%. In order to secure the loan in the event of insolvency, the bank also requires a registration of its land charge in the land register, in the first place. So if the loan threatens to go under, the bank can auction the property and thus get the entire loan amount back.

Now the remaining EUR 2.000.000 of the purchase price should also be available with external financing. However, since the bank’s mortgage is already in the first place in the land register and it basically accounts for the entire asset of the encumbered property, it is unlikely that another bank will support the project with a loan. After all, in the event of insolvency, this could mean that she would have to write off her loan, because her mortgage would then be secondary. Therefore Immobilien-GmbH takes out the loan from its parent company. For this purpose, a rather high interest rate of about 8% is agreed with her.

Although this interest rate appears very high in times of negative interest rates on the interest rate market, it can withstand an external comparison. This is because the lending parent company compensates for its increased default risk. And this would also be handled by another lender.

Now let’s move on to taxation. In order to be able to collect rental income tax-free, we have to reduce it with an offset. So we compare rental income with the highest possible costs and other deductions.

Of course, the first costs that come to mind are repairs and maintenance measures. However, apart from the fact that they contribute to the reduction of the tax, there is no real advantage. Therefore, we want to assume in our model that no such costs have to be taken into account.

3.2.1 Debt financing costs as an expense

However, we rather benefit from the high ongoing debt financing costs. On the one hand, we have to factor in the interest on the bank loan. With an interest rate of 1%, EUR 80,000 of interest accrues annually.

On the second loan of EUR 2.000.000 we have to raise 8% in interest. That is EUR 160,000. Together with the other interest rates, we have achieved a reduction in rental income of EUR 240,000. As we will see in a moment, debt financing costs contribute significantly in this way to collect rental income tax-free.

3.2.2. Interest as a hidden profit distribution?

Now, however, it must be noted that excessive interest rates cannot be justified in taxing capital income if they flow to a related party or an affiliated company. Instead, the tax administration usually classifies such situations as a hidden profit distribution. Consequently, the interest arrives at the recipient as dividends. More serious, however, is that excessive interest rates are then no expenses and are therefore unsuitable for reducing rental income. So excessive interest payments are usually unsuitable to collect rental income tax-free.

In our case, however, the high interest rates the parent company receives do not constitute a hidden distribution of profits. Finally, there is an arm's length comparison due to the increased risk of default with regard to the loan. Therefore, one can actually consider the interest rates, despite their comparatively unusual amount, as appropriate expenses.

The calculation of the depreciation of the property remains. It takes place annually at 2 % of the acquisition costs. So it contributes with EUR 200,000 to the real estate GmbH can collect the rental income tax-free.

Immobilien-GmbH thus pays corporate tax on its heavily reduced rental income. After deduction of depreciation and debt financing costs, only EUR 60,000 remains here. With a tax rate of 15%, there are finally EUR 9,000 on rental income of EUR 500,000.

Since Immobilien-GmbH is subject to trade tax, we must also refer to this. But at once we can see that this tax is dissolving into pleasure. Because if Immobilien-GmbH does not generate any income other than through the rental of real estate, in particular no commercial, then you can submit an application to the tax administration. This is based on § 9 no. 1 sentence 2 GewStG, which provides for the exemption from business tax if the stated condition is fulfilled. For this there is the term extended land shortening.

So you can practically say that in this constellation you could collect the rental income tax-free.

Finally, the parent company receives the interest from its subsidiary Real Estate GmbH. If the parent company is a company abroad, then it must tax the interest there. If the interest in this way reached a country that either does not tax foreign income or does not tax income of this kind, then the rental income could also be collected virtually tax-free.