BFH: Payments for the waiver of a housing right as immediately deductible income-related expenses

On September 20, 2022 (Ref.: IX R 9/21), the Federal Fiscal Court (Bundesfinanzhof, BFH) issued a landmark decision on immediately deductible income-related expenses. The decision provides clarity in a previously disputed borderline area of the tax classification of compensation payments for the redemption of rights of use to real estate as immediately deductible income-related expenses pursuant to Section 9 (1) EStG or subsequent acquisition costs. It should please many of those affected.

The theme:

A man brought an action before the Lower Saxony Fiscal Court against the Fiscal Authority (Finanzamt -FA) because the Fiscal Authority (Finanzamt -FA) had not recognized compensation paid by him to a tenant for the relinquishment of her gratuitous housing right secured in rem (Section 1093 of the German Civil Code (Bürgerliches Gesetzbuch - BGB)) to a property previously acquired by the plaintiff by way of universal succession as immediately deductible income-related expenses when determining his income. Instead, the FA and, following it, the Tax Court regarded the compensation payment and the associated notarization costs as subsequent acquisition costs of the residential building and took into account the expenses borne by the plaintiff in this respect by increasing the depreciation to be recognized in the year in dispute. The plaintiff contested this in his appeal. In his view, the expenses were incurred solely to rent out the building and thereby generate income.

The decision:

The BFH followed the plaintiff's view and overturned the tax court ruling. The BFH initially based its decision on the wording of Section 9 (1) sentence 1 EStG. According to this, income-related expenses are expenses incurred to acquire, secure and maintain income. They are to be deducted for the type of income of renting and leasing if they are "incurred" for this type of income (cf. Section 9 (1) sentence 2 EStG), i.e. if they are caused by it. According to the established case law of the Federal Fiscal Court (Bundesfinanzhof, BFH), which the BFH emphasizes once again here, expenses incurred in connection with the intended rental of a residential property that is yet to be renovated can be taken into account as income-related expenses incurred in advance if there is a sufficiently specific economic connection between the expenses and the type of income in the context of which the deduction is sought. It is precisely this economic connection between the expenses incurred for the elimination of the gratuitous right in rem to reside and the generation of income from the subsequent rental, which was only made possible as a result, that the BFH considers to be given in the present case. Only by paying the compensation amount was the plaintiff able to eliminate the gratuitous transfer and replace it with a transfer for consideration. The possibility of using the property for a consideration thereby created establishes the connection between the expenses incurred and the income and, in the opinion of the BFH, overrides the real connection that existed first.

Classification:

The BFH's decision does not represent a change in the BFH's previous case law. Rather, it can be seen as a continuation and clarification of the BFH's existing decisions on the subject of income-related expenses. This is because the BFH is sticking to its (older) case law, according to which, for example, an acquisition transaction is deemed to have taken place if the owner of a piece of real estate redeems a right in rem or a right granted by bequest in order to be able to use the real estate himself at a later date or in order to end existing disagreements with the owner of the right to live there. In these cases, there is still no economic connection between the expenses incurred and the (future) generation of income from renting or leasing.

It can therefore be stated as a mnemonic for demarcation:

• Income-related expenses pursuant to Section 9 (1) sentence 1 EStG exist if the compensation payment relates specifically to intended income,
• on the other hand, such compensation payments that cannot be specifically related to income are solely object-related and then (additional or subsequent) acquisition costs.

Practice Tip:

In relevant cases, it should always be checked and, if necessary, recorded in writing whether the expenses incurred (severance payments) can be specifically related to intended income. If this is the case, the expenses can be taken into account as immediately deductible income-related expenses. Otherwise, the expenses increase the acquisition costs and can - in the event that income is generated at a later date - only be claimed as costs via depreciation.

LHP Rechtsanwälte Steuerberater offers legal and tax advice on the tax optimization of compensation payments for the redemption of such rights in rem. We will be happy to advise you on the possible form of such redemption agreements.