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Tax rental income
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How is rental income to be taxed? This is an important question if you are thinking about buying and renting a house in Switzerland. The general rule is: According to Article 6 of the DTA Germany-Switzerland, income from renting a property is generally taxable in the country in which the property is located. This also applies to income from the rental of real estate as a business asset. However, rental income can also be taxed in the country in which the owner of the property is tax resident. The tax levied in the other country is then taken into account (Article 24). To date, the German tax authorities have generally subjected any pro rata rental income from real estate in Switzerland to German taxation.

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Taxing rental income: change in case law

If the real estate is used for business purposes, an addition was made in accordance with the Foreign Tax Act. The BFH has now overturned this. This was long overdue, because the tax administration's perspective did not take into account that an investment in a property in Switzerland should be treated in the same way as an investment in a property in any other EU member state via the bilateral contracts.

In which country is the rental income taxable?if the property is in Switzerland? Income of a taxpayer resident in Germany from the rental of a property located in Switzerland is therefore excluded from the assessment basis for German tax if the property “serves” a permanent establishment that generates its profits from one of the active activities mentioned in the DTA. According to a ruling by the First Senate of the BFH, this presupposes that the rental income is ancillary income which, according to the public opinion, belongs to the activity in which the focus of the business activity carried out in the permanent establishment lies (functional approach).

Special case of interim income

However, despite a violation of the free movement of capital, the BFH allows interim income generated in the financial years 2004 to 2006 in the sense of § 8 Abs 1 AStG, since the violation was justified and therefore in accordance with the requirements of the ECJ ruling v. February 26.2.2019, XNUMX –C ‑ 135/17, X not against Union law. Violates. (BFH, decision of September 30.9.2020, XNUMX –IR 12/19). In all cases of corporate property ownership, it must therefore be checked whether there is a so-called “intermediate company” and how this can be avoided.

Allocation of interest and financing

Rental income is taxable in Germany and Switzerland. However, the two countries have different regulations for determining the taxable result from the rental of real estate. You do not have to declare owner-occupied real estate in the declaration in Germany. No imputed rental value is taxed for these properties, and no costs may be deducted. In Switzerland, on the other hand, the property you use yourself is treated as if it were rented out. Accordingly, an imputed rental value must be declared as income for personal use.

In plain language, this means that rental income is taxable even though the property is not rented to third parties. 

However, the costs can be deducted. The income from third-party rentals is equally taxable in both countries, although, as mentioned at the beginning, the taxes are offset against each other.

What are the taxes on rental income?

When determining income from renting and leasing, interest that is directly related to the purchase or renovation of the building is also deducted in Germany. Things are different in Switzerland, because debts and interest are not taken into account on a property-specific basis, but are allocated proportionately to the entire assets. 

This leads to a division of all debts and interest even if assets are located in different Swiss cantons. This also applies to assets in several countries. As a result, every time there is a change in assets, one should consider what impact this has on Swiss taxation.

For example:

A citizen living in Switzerland has a self-used home worth a million and has debts of half a million on it. He also has a securities portfolio worth 200.000. Both the debt and the interest can be deducted in full for tax purposes.

Tax the rental income correctly: Examples Switzerland - Germany

  • If this person inherits a debt-free property in Germany worth 1,2 million, then the Swiss tax office will offset the debts existing in Switzerland proportionately and thus allocate half to the German property. In Switzerland, all of the debt is no longer deductible, nor is all of the interest. However, Germany does not allow interest to be deducted because the property-related approach is taken here.

  • If the person buys a property in Germany worth 1,2 million and finances it by taking out a loan in full, but then pledges the securities account, then the tax is calculated differently. Germany allows interest deduction for the financing of the property in full. In addition, 50% and so 600.000 can be deducted from Swiss assets as debts. When determining the taxable income in Switzerland, 50% of the interest for the German property is deducted, although this interest has already been taken into account in Germany when determining the taxable income there.

Remodeling and renovation

Since you're not currently getting much interest on your savings, many landowners are investing in converting and renovating their properties. But here too you should consider how future rental income will be taxed. In Switzerland, the costs of value-adding renovations cannot, in principle, be deducted from taxable income. In Germany, however, the deduction is possible in principle, although this does not normally have an effect on owner-occupied properties. 

Nevertheless, it is always worth keeping the receipts, even in Switzerland. Because unlike in Germany, where the sale of a property is tax-free after 10 years, the sale of a property in Switzerland is taxed. When selling, proven, value-enhancing investments can be added to the original purchase price and consequently deducted when determining the taxable property gain. 

The costs for value-preserving renovations, i.e. for work that serves to maintain and maintain the property, can also be deducted from taxable income in Switzerland. There are two ways to claim the tax deduction: the flat-rate deduction and the effective proof of costs. The federal government and most cantons allow you to decide every year which method should be used. Flat-rate deductions can be permitted even if no costs can be proven. In Germany, however, you have to provide proof of every expense.

acquisition cost

Anyone who purchases a property in Germany and then renovates or converts it should inform themselves in good time and create a plan for the sequence of work. If the sum of the renovation costs incurred in the first 3 years after the purchase is higher than 15% of the purchase costs, or if more than 3 trades (windows, plumbing, roof) are tackled in a certain time period, then these costs may be are no longer immediately deductible but must be added to the acquisition costs and can then only be depreciated over the expected useful life. 

If you keep an eye on it and pay attention to the special tax requirements, you could buy a used property in Germany and gradually renovate it to increase its value according to the criteria mentioned. Ideally, this property as well as the renovation costs are financed with as much debt as possible. Citizens resident in Switzerland can thus generate an additional interest deduction. The current income in Germany we had reduced the full interest deduction and the renovation costs. If you sell the property after 10 years, the entire profit remains tax-free.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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