To save on real estate taxes, you have to set all the course from the beginning. It is of immense importance to assess the respective situation as accurately as possible. Because the choice of the optimal legal form depends on the framework conditions of the individual properties. And the legal form ultimately determines the type of taxation, in particular the possibility of selling real estate tax-free. This is especially useful if one assumes a high increase in value. Conversely, a real estate GmbH is advantageous precisely when you achieve comparatively high rental yields.

1. Saving Taxes with Real Estate – Introduction

Do you know how best to save taxes? Well, the most important thing is to design taxes in advance. This means that you already know in advance which investment will pay which tax in the end. Because those who simply venture into a financial adventure unprepared can often only marvel at the tax consequences. Anyone who then runs quickly to a tax consultant to correct this, often has the disadvantage. So, it is better to take action well-informed than to go the long way to knowledge.

Why are we telling you this? The reason for this is hardly as relevant for an investment as for real estate. You can only save on real estate taxes if you take a long-term perspective. As a rule, one can assume at least one ten-year period. Ten years are relevant for tax savings with real estate because this corresponds to the speculative period, after which the private sale of real estate can take place tax-free. And since this is a particularly important factor in most cases, we also highlight it right at the beginning.

2. Starting situation in tax savings with real estate

Now let’s see how you can get the highest return on certain properties, which also means that taxes are as low as possible, from the time of purchase to the rental to the sale. The most important marker here is the return on equity, because this also takes into account the borrowing of debt. But also very important is the legal form with which we would like to carry out the asset management of real estate in our considerations. On this depends both the taxation of current rental income and that of the sales profit.

The starting point is the purchase of real estate with acquisition costs of an exemplary EUR 10 million. Here we want to distinguish three cases. On the one hand, the property should be in a very good location, which allows an annual increase in value of 2.5%. However, the return on rental income is relatively low at 3 %. A second variant of our considerations is an average property, where neither appreciation nor loss of value can be expected and the rental yield with 5% is the only advantage. And in the third case, it is said to be a property whose value even decreases by 2.5% year after year, but the rental yield is quite high at 8%.

In all three cases, we take out a loan that covers 80% of the acquisition costs and for which we pay interest at an interest rate of 3.8%. In all three cases, we want to make the repayment through the savings made by depreciation at a rate of 2%. The sale of the properties takes place after a term of ten years.

What we want to do without for simplification is the possibility of rent increases and that other expenses become relevant, for example for repairs. Admittedly, this is unrealistic, but it simplifies our calculations without the basic principle of our assumptions being significantly compromised.

3. Save Taxes with a Property in Top Location

3.1. Calculation of profit

3.1.1. Rental of the property

The property in the top location gives us annual rental income of EUR 300,000. At the same time, we also have interest expenses of about EUR 300,000. Thus, a tax loss of EUR 200,000 remains due to the depreciation (AfA). In the case of a private rental or a rental through a partnership, this purely tax loss can of course be used to offset other positive income with them. In this indirect way, you can also save taxes with real estate. However, if you are a single person with a taxable income of around EUR 250,000, you save only 40% on income tax, because that is where the average tax rate we want to adopt here lies. Thus, by compensating for losses, we obtain a tax advantage or compensation of EUR 80,000.

But what we still have to consider is the repayment of the loan. We actually wanted to use depreciation in all three cases, but it turns out that rental income is too low. Consequently, another source is necessary to carry out the repayment as planned. Since we already assume a high income, and this is only subject to income tax with EUR 50,000 due to the high real estate depreciation, the repayment should nevertheless be possible.

3.1.2. Sale of the property

After ten years, we have already repaid EUR 2 million of the EUR 8 million loan. So let’s sell the property, which is now worth about EUR 12.8 million at the assumed annual increase in value due to the compounding effect. If you deduct the residual tax value (book value) from this sales proceeds, we can record a profit of EUR 6.8 million. However, in the overall assessment we also have to take into account the loss caused by the repayment. Because of the AfA over EUR 200,000 annually, we could only book EUR 80,000 as a financial advantage. The remaining EUR 120,000 thus add up to EUR 1.2 million over the period under consideration. Therefore, we have to deduct these from the sales profit as well. Thus, only EUR 5.6 million remains as a profit.

3.2. Calculation of the return on equity

On this basis, let us now calculate the return on equity over the entire term: it is just under 11%. The direct comparison is much more attractive: of the EUR 2 million we invested in the property, EUR 5.6 million has become in the end. This is exactly 2.8 times our equity. However, we assumed that we could make the sale tax-free, which is only possible as a private person or as a partnership. In any case, this shows that real estate can achieve a nice return by saving on taxes.

4. Saving Taxes with an Average Property

4.1. Calculation of profit

For the average property, we have annual rental income of EUR 500,000. Of this we subtract about EUR 300,000. So EUR 200,000 remains in the account, which we now use for annual repayment.

From a tax point of view, we have to tax EUR 500,000 on the one hand, from which we can deduct EUR 300,000 in financing costs. We also deduct the AfA, which is ER 200,000, so our rental remains virtually tax-free.

Since we sell this property for the same value we received when we bought it, we need to take a closer look at the profit. For example, we have paid EUR 2 million over the ten years. This leaves a residual debt of EUR 6 million, which we have to deduct from the sales proceeds of EUR 10 million in order to determine the true value of our profit. The prerequisite here is also that we have made the sale tax-free.

4.2. Calculation of the return on equity

With this real estate investment, we have doubled our equity within ten years. This corresponds to a return on equity of at least 7 % over this period. At virtually no time have we paid taxes.

5. Save taxes with a property whose value decreases

5.1. Calculation of profit

In this property attracts a rental yield of 8%. At the end of each year, we can look forward to rental income over EUR 800,000. However, on the one hand the repayment of EUR 200,000 and on the other hand the interest of EUR 300,000 are decreased. And we also have to pay taxes on the remaining EUR 300,000. Since we have charged the repayment with the AfA, we must not withdraw it again. Consequently, we have to tax EUR 300,000 as income. If we tax this income via income tax, live alone and have no other income, the tax on this is about EUR 122,000. Multiplying this by ten, EUR 1.220,000 in income tax is incurred in our period under review. Of the EUR 3 million in rental income, EUR 1.780,000 remains after ten years, after deduction of interest and repayment.

However, we must also take into account the depreciation that has taken place at a steadily increasing rate over the ten years. In fact, we end up with a value of EUR 7.8 million, for which we can ultimately sell the property. The loss in value is thus EUR 2.2 million. After all, enough value remains to compensate for the remaining debt of EUR 6 million. This lands us at a value of EUR 1.8 million, which we can quantify as a profit from the sale of the property.

5.2. Calculation of the return on equity

However, we also have to add to the profit from the sale of the property the total income from the rental. As a result, EUR 1.8 million is added to EUR 1.78 million. When determining the return on equity, we therefore assume a total result of EUR 3.58 million. The return on equity is thus just under 6 % in this example.

6. Saving Taxes with Real Estate – Conclusion

So, as you can see, the result of asset management with real estate on the one hand is very much dependent on the circumstances that accompany the real estate itself. This includes in particular the location and the rental yield. These conditions in turn influence the choice of the legal form with which the asset management is carried out.

In our three examples, it is the case that only in the third variant a real estate GmbH has the potential to save on real estate taxes. Because the rental income is then only subject to corporate tax at 15%. The trade tax can be excluded via the extended land reduction. Since the property value has fallen below the acquisition cost until the sale, the tax liability on the sale does not constitute a significant disadvantage compared to the tax-exempt income tax. If, contrary to expectations, a taxable profit should arise, you can still exercise the option of the so-called 6b reserve with a real estate GmbH (§ 6b EStG). Because then you can leave the profit untaxed for up to six years in order to acquire new properties within this period.

On the other hand, with the first two models, the relatively high return can be used to obtain additional financing from the banks for the acquisition of new properties. After all, we have at least doubled our own capital. The leveraged acquisition of similar or comparable real estate should therefore be realistic.

In any case, all this should illustrate how important it is in tax design that you are well advised from the beginning. Because who wants to use tax advantages, should not rely on chance.