Disposal transactions in case of property division

Disposal transactions in case of property division

Disposal transactions can trigger tax liability as other income from private sales transactions in accordance with Section 22 and Section 23 German Income Tax Act (EStG), even if these only relate to certain assets held as private ones. The assets whose sale can lead to a capital gain or loss are listed exhaustively in the latter provision. The prerequisite for establishing tax liability is the sale within certain periods specified in the law.

In the case of property or the rights related to it, the relevant tax period between acquisition and disposal is ten years; buildings and the associated land that were used exclusively or at least in the year of disposal and in the two preceding years for own residential purposes are not subject to taxation. The relevant period for other assets is one year. Items of daily use are generally exempt from taxation.

In its ruling dated 26.09.2023 (case reference IX R 14/22), the German Federal Court (BFH) addressed the question of whether the division of a property previously used for own residential purposes and the subsequent sale of an undeveloped part of the property constitutes a private sale transaction subject to income tax. The plaintiffs are husband and wife who each acquired half of a property in 2014. Their home, which they have used themselves since 2015, is also located on the property. When construction was started in the neighborhood in 2018, the couple decided to sell part of their property as building land. In close temporal connection with sales talks, the plaintiffs arranged for the property to be divided into two parcels.

When the undeveloped part of the property was sold in 2019, the plaintiffs did not include any resulting income in their tax return. They justified this by stating that they had only sold part of their garden from their self-used property; in their opinion, there was no taxable private sale transaction, as they could also have sold the undivided property tax-free before the end of the ten-year period. However, the tax office assessed this differently and determined a capital gain from the sale of the property in the income tax assessment of the couple.

The tax office's approach was confirmed both by the Lower Saxony tax court in the lower instance and by the BFH. The division of the property into two parcels meant that each parcel was given a partial economic identity and must therefore be considered separately. From a conceptual point of view, only the residential building can be used for own residential purposes; the land belonging to it forms a separate asset for tax purposes. According to the jurisdiction, the decisive factor for the existence of a property used for own residential purposes is that there is a uniform usage and functional connection between the residential building itself and the land on which the residential building stands. According to the BFH, this connection does not apply if a part of the previously undivided residential property (in this case undeveloped) is separated for the purpose of sale and development and purposefully prepared for transfer to a new purchaser.

In this context, the BFH states that the division of the property alone does not lead to a taxable private sale transaction, but only the lack of a uniform usage and functional connection between the newly created property and the residential building. This is because the purpose of the tax exemption is not to hinder professional mobility - by taxing a capital gain on the sale of the residential property.

In the case in dispute, the division of the original property created a further - albeit partially identical - asset, which was intended by the couple from the outset for sale and not for their own use. It is irrelevant how the new property was actually used prior to its separation and sale. In the opinion of the BFH, a private sale transaction from the sale of the undeveloped part of the property is therefore to be assumed for the taxpayers.
 

Note:
In principle, the BFH leaves it open that not every sale of a divided property leads to a taxable private sale transaction. From an income tax perspective, it is nevertheless advisable to avoid the occurrence of the described taxable event by choosing the date of sale outside the ten-year period; at least Section 23 EStG allows for this possibility.