When losses occur at the private level, a number of provisions apply that regulate offsetting against future positive income. For example, losses from stock transactions are in principle only offsettable with profits from other stock deals. However, there are some legal loopholes that indirectly allow offsetting with other profits. So how to use losses despite the fact that the tax laws actually oppose this, we explain in this article.

1st use of losses – Introduction

Winning is great! What would our world be without the thrill of fighting for something? Sure, there would be no wars and no envy, but also no football championships, no Olympic Games and no sport at all. Or games. Or betting. And of course there would be no entrepreneurship, at least no profit-oriented one. Even socialism never managed without competition. And the story of Cain and Abel also shows that even in ancient religions the concept of competition, where you often only know one winner, is understood as too human.

But on the other side is the loser and the loss. Usually then a bet that you have to make to secure the chance of a profit, well, lost. Why should taxation be any different? In fact, this is less drastic in tax law than in the Old Roman gladiator arena (fortunately). However, only in certain cases and often only under special conditions. Because tax law knows a large number of restrictions that make it difficult to use losses.

But what kind of tax consultants would we be if we didn’t know a way out of this? Well, I think we owe you an answer to that question. Well, we know and now show you how to use losses for tax purposes even if their use is actually excluded under the law.

Use losses at the private level: where are the tax hurdles?

We want to focus on four aspects: share losses as well as losses from shareholdings and from private assets, with a particular focus on real estate in private assets.

In addition, we have yet to define what we regard as a loss in this context. On the one hand, there is the classic loss resulting from divestment transactions. Here share losses are very prominent, but also those from the sale of company shares or real estate. What one may think less about at this point are objects of private use, such as art objects, a classic car collection, a yacht or a private jet.

This brings us to a second aspect, namely the creation of losses by loss of value. This is also the case if no sale takes place. If you had a GmbH in which a value loss occurs, then you could show the effect in the balance sheet.

Which leads us to the third point: At the private level, the recognition of losses arising from interim or permanent impairments is excluded.

But it goes even further: Anyone who registers losses in the GmbH as a GmbH shareholder can also not use them for tax purposes on a private level. This applies both to business losses of the GmbH and to partial value write-offs of assets in the operating assets. This may, for example, be an obsolete plant, but it will still be written off. Its book value would still be above EUR 0, but still below the market value.

3. legal bases that restrict the use of losses

Since we have now set the framework of our investigation, we still provide the legal regulations that we have to comply with. The general provisions on the recognition of losses at the private level provide § 10d EStG.

In addition, there are specific special provisions. For example, if we want to use losses from share transactions, then § 20 paragraph 6 sentence 4 EStG is relevant here. But also other losses from capital assets are affected by restrictions, which at best allow offsetting with future profits from other capital income. Incidentally, the offsetting of losses from futures contracts is particularly strictly regulated.

The situation is similar for private divestment transactions (Section 23(3), seventh sentence and 8 EStG). For example, those who sell real estate from private assets at a loss may only offset the loss with profits from other private sales transactions. First of all, losses of this kind incurred in the same calendar year are priority. Otherwise, either a loss transfer or a loss carry forward is possible. The offsetting with positive income of other types of income, however, is excluded. And what applies here to real estate, then applies accordingly to all other assets of the private property.

4. How can you use losses despite the contrary legal situation?

Since the tax regulations that regulate the use of losses at the private level and severely restrict or even completely exclude them, are very clear and thus unequivocally reflect the intention of the legislator, one has to dig quite deep into the trickbox in order to make losses usable.

4.1. Designing the use of losses at the private level

For this we need a GmbH and two shareholders who are ideally spouses. In doing so, we can also assume that the GmbH has already generated losses from which the shareholders at the private level were initially not able to draw direct tax benefits. Now, in addition to the participation in their GmbH, the spouses also have real estate, shares and a private jet in their private property. For everyone, they have to expect significant losses in value, i.e. losses that they can use with considerable restrictions at best. They now transfer these loss-prone assets to their GmbH. The GmbH now determines the impairment and shows it in its balance sheet by means of partial write-down. This deficit consequently reduces the value of the GmbH shares of the spouses. However, this has no influence on taxation in the context of their income tax assessment.

But if they sell their holdings to their respective partners, the following happens: The profit on the sale of the holdings is determined by comparing the acquisition costs to the sales price. Since the selling price is lower than the initial cost due to the loss in value of the GmbH shares, both spouses record a loss through the sale of their shares. Curiously, however, this type of loss is very much attributable to other positive incomes. If, for example, the spouses earn high income from self-employment, for example because they are doctors or architects, then they are allowed to offset the losses from the sale of their GmbH shares with this income – and thus use the losses indirectly.

4.2. Legal consideration: is there design abuse?

Admittedly, this is a legal loophole for the benefit of taxpayers. Now, however, such a ring sale among shareholders is extremely suspect. Even a simple clerk at the tax office is likely to hear the alarm bells ringing: § 42 AO design abuse! If one assumes, for example, that both spouses are each 50% in the GmbH, then such a ring sale only makes sense if one takes into account the resulting usable losses. But this is precisely what § 42 AO is supposed to prevent, namely that actions are only taken to avoid taxes that would otherwise be incurred. Therefore, the second legal loophole that we use here is all the more astonishing, because it comes from the BFH’s permanent jurisprudence. In 2010, the highest authority for tax matters ruled that ring sales among shareholders do not constitute abuse of design per se. Even the financial administration has now accepted this.

Unlawfully and yet legally use losses – Conclusion

Losses are a sometimes delicate topic in tax law. For example, the Federal Constitutional Court has dealt with the question of whether the state has to take into account not only profits but also losses when collecting its taxes. Since there was a clearly positive response, the legislature had to follow other paths to regulate the offsetting of losses. This was apparently done primarily to prevent abuse in the approach of losses. The fact that this can very easily lead to high tax losses is obvious.

Therefore, it is also partly a moral question whether one considers other ways to take advantage of losses for which no simple accounting is actually provided. On the other hand, one can question whether the actions of the legislature, with all its limitations regarding the offsetting of losses, correspond to general ideas of justice. But no matter what outcome these considerations ultimately lead to, such a design is definitely feasible.