For income tax purposes, the production costs of a building also include expenses for repair and modernization measures carried out within three years of the acquisition of the building if the expenses, excluding VAT, exceed 15 % of the acquisition costs of the building, so-called acquisition-related production costs (Section 6 (1) no. 1a of the German Income Tax Act). These expenses are not immediately deductible as income-related expenses, but can only be claimed over time via building depreciation. Against this background, the German Federal Fiscal Court had to clarify the legal question in its ruling of September 20, 2022 (Case No. IX R 29/21) as to whether paid leasehold indemnities are immediately deductible income-related expenses in the case of income from rent and lease or whether these are to be qualified as acquisition-related production costs.
In the case in question, a civil-law partnership (GbR) acquired a rented property in March 2016 for a purchase price of EUR 1,200,000 and renovated it by 2018 for a total of around EUR 615,000. In order to persuade the lessees to terminate their rental agreements and leave their apartments, and to be able to carry out the renovation work, the GbR paid indemnities totaling EUR 35,000. The GbR claimed the leasehold indemnities as immediately deductible income-related expenses. The tax office and the tax court, however, qualified these payments as acquisition-related production costs. The German Federal Fiscal Court disagreed.
This is because, in the opinion of the German Federal Fiscal Court, acquisition-related production costs within the meaning of Section 6 (1) no. 1a of the German Income Tax Act are limited exclusively to building measures on the building’s equipment or on the building itself. This includes, in particular, expenses which - without the above-mentioned restrictive regulation - would in principle be assessed as maintenance expenses, such as, for example, repair or renewal of existing sanitary, electrical and heating systems, floor coverings, windows and roofing. Accordingly, leasehold indemnities do not constitute building measures, even if the payments are made in order to induce the lessees to leave their apartments and to be able to carry out the renovation work. Consequently, they do not count as acquisition-related production costs. A possible (direct or indirect) causal connection between the costs - such as the leasehold indemnities in this case - and the repair and modernization measures is irrelevant.
Although the concept of acquisition-related production costs is based on the assumption that the purchase price was calculated at a lower level precisely in view of the necessary maintenance expenses, so that the catch-up is part of the purchase price from an economic point of view. However, this consideration also only applies to expenses for repair and modernization measures (building measures), but not to leasehold indemnities. This is because these are not typically reflected in a permanent increase in the value of the building, so that the purchaser will not normally have any reason to compensate the seller for them in the form of a higher purchase price.
The leasehold indemnities are therefore immediately deductible as income-related expenses in the case of income from rent and lease.
Notice:
The German Federal Fiscal Court ruling is extremely welcome and provides legal certainty in consulting practice. However, it should be noted that the case is different regarding leasehold indemnities, which are used to demolish a previously rented building and to construct a new building on the same place without any conflicting rights of third parties; such payments are part of the original production costs of the new building.