The selling of several properties (leased to third parties) can give rise to various delimitation issues for income tax purposes. Whereas in the case of income tax for private individuals or partnerships, a so-called commercial real estate trading can take the place of a private sales transaction, this does not play a role in the case of corporations in view of their extensive commercial income. However, regardless of the legal form, follow-up questions regularly arise in the area of trade tax law, in particular with regard to the use of the so-called extended property reduction within the meaning of Sec. 9 (1) Sentence 2 of the German Trade Tax Act. Accordingly, in the case of companies that exclusively manage their own real estate, i.e. precisely do not buy and sell real estate on a short-term basis, the resulting income is not subject to trade tax; however, any proceeds from the sale of corresponding properties that were previously the subject of real estate management are also privileged. Commercial real estate trading would exclude this privileged treatment as an activity that goes beyond mere management.
The existence of commercial real estate trading is generally assumed along the so-called three-object-limit, which is based on prima facie evidence and circumstantial evidence, if at least four properties are sold within a close temporal connection between acquisition or construction and selling, i.e. within approximately five years. However, real estate that is sold after the expiry of five years but within ten years of acquisition may nevertheless be attributable to commercial real estate trading if special circumstances arise. This is the case, for example, if the five-year period is exceeded only slightly, if a larger number of properties is sold, if a main profession related to the business is exercised, or if continuous property purchases and sales are made.
In view of these principles, the Muenster Fiscal Court had to deal with a very practically relevant case in its ruling of April 26, 2023, Case No. 13 K 3367/20 G, and took this as an occasion to comment on the further prerequisites of commercial real estate trading in connection with the extended property reduction within the meaning of Sec. 9 (1) Sentence 2 of the German Trade Tax Act.
In the case in question, a German limited liability company (GmbH) sold thirteen properties; twelve of the thirteen properties had been held as fixed assets by the GmbH for at least five and a half years. Following an external audit, the tax office refused to grant the extended property reduction applied for in the trade tax return within the meaning of Sec. 9 (1) Sentence 2 of the German Trade Tax Act, as the GmbH’s property management activities had gone beyond pure asset management and the property sold had crossed the line into commercial real estate trading. The Muenster Fiscal Court took a different view. This was because the thirteen properties were only sold after the expiry of the five-year period taken as a basis by the case law.
There were also no special circumstances in the individual case which, despite the fact that the five-year period had been exceeded, gave rise to a conditional intention to sell which was already present at the time of acquisition and which meant that commercial real estate trading had to be assumed, as the detailed examination by the Muenster Fiscal Court shows:
- The business purpose of the GmbH was merely the management of its own real estate by renting and leasing; it therefore did not exercise a main profession related to real estate trading, such as an activity as a real estate agent or an activity in the construction sector. The fact that, in addition to the GmbH, the group of companies also included companies whose respective business purpose was real estate trading or a construction activity is, in the opinion of the Muenster Fiscal Court, irrelevant for the assessment of the GmbH in question despite the identity of the managing directors between the companies within the group of companies due to the principle of separation for corporate income tax purposes.
- The case law of the German Federal Fiscal Court has until now assumed that a period of two months constitutes a slight exceeding of the five-year period. In the case in question, however, the five-year period was exceeded by five months in the case of one property and by at least six months in the case of the twelve other properties; in the opinion of the Muenster Fiscal Court, a period of six months is not merely “slight” - at least in the case in question.
- In the case of full debt financing, the German Federal Fiscal Court did see a conditional intention to sell that already existed at the time of acquisition. In this respect, it could not be ruled out that a need for funds would arise and that, as a result, a part of the acquired properties would have to be sold. In the case in question, however, there was a high level of external financing, but not all of it. In addition, the loans were essentially agreed with a longer term and were subject to a fixed interest rate, which in the opinion of the Muenster Fiscal Court also did not indicate that the properties would have to be sold in the near future.
- With regard to the numerical selling of thirteen properties, the Muenster Fiscal Court admitted that this was a high number compared to the three-object-limit. However, in addition to this one indication, which could speak for a conditional intention to sell already existing at the time of acquisition, further special circumstances of the individual case must be taken into account after the five-year period has been exceeded in order to be able to assume a commercial real estate trading. As a rule, an unexpected private motive to sell does not shake this indicative effect if the three-object-limit is exceeded within the five-year period. However, in the case in question (sale of thirteen properties outside the five-year period), the Muenster Fiscal Court considers the specific reason for the sale - the unexpected death of one of the shareholder-managing directors - to be acceptable. This is because the event was so serious that there were no foreseeable indications of it at the time of acquisition.
Notice:
The appeal allowed by the Muenster Fiscal Court due to fundamental importance is pending before the German Federal Fiscal Court, III R 14/23. Similar cases should be kept open until the German Federal Fiscal Court has reached a decision.