Through our consultancy assignments, we are frequently coming across avoidable mistakes resulting in unnecessary tax payments. A conversation with your Tax Consultant/Accountant could be a worthwhile investment but it only works if you are prepared to provide the right information and ask the right questions. Depending on how long ago you bought your property, there are different aspects to be considered: Pre-Acquisition phase, Operation phase and Sales phase. In this article, I will focus on the Operation phase, whilst provide some general background on the other two areas.
Pre-Acquisition
In most cases, the documentation of costs incurred before the purchase of a property, we call it Pre-Acquisition phase, is very poor as there is no certainty about the success of finding the right property. This is amplified when the process involves a tax period other than the one a property was bought in.
Here are some examples of items that could be used as deductions on your tax return:
- travel expenses including rental car, taxi and reasonable restaurant expenses;
- advisors for research and due diligence on properties, even if it is for properties not bought in the end.
If these cost items were not part of your returns you might want to find out if the tax assessments for the years concerned are final yet. Frequently tax authorities issue the assessment reserving the right to review documentation at a later point (“Vorbehalt der Nachprüfung”). In this case, you might be able to correct the tax return. For details, you would have to refer to your accountant.
Operations
The focus of attention is on this Operations phase of the property cycle because as with any other issues during the operational phase of a property, any mistake is likely to be repeated year after year. This provides the biggest opportunity secure the financial outcome of a property investment.
Here is a list of items deductions could come from, it is not comprehensive and in some cases might not apply. It is up to you and your accountant to determine your individual situation.
- Travel expenses including car rental, taxi and reasonable restaurant expenses.
It is recommended to include some notes on property inspections, meetings with the property manager, bank, accountant etc. to document the relevance of these activities for the investment.
- Banking. This might not be obvious to everybody but the cost for a banking account solely for the management of the property for receiving surplus, covering indirect cost etc. can be used as a deduction.
- Financing. In many cases, funds used as “equity” in a property investment are partially or completely financed through a different source with different collateral at home. If the direct connection with the investment can be shown the related cost can be deducted in your German tax return.
- Investments and payments to tenants. By applying different rules which relate to the size of investment and time proximity to the purchase date, investments can be either written off over a defined period or deducted immediately. Here it is important that there is an established process to ensure that all costs are fed into the tax return. More details on this follow in the next section.
Setting up the Right Processes
Let us start this section with a little case study. We recently received this real life message:
Hi. Having purchased 2 tenanted apartments in 2007 due to old tenancy agreement on one of these properties I eventually had to pay 10k to Tennant to vacate property then I refurbished & sold it. However, the accountancy firm failed to file this with my yearly accounts and I failed to obtain any credit for this outlay. Most frustrating. Is it possible to have a reputable management company & accountancy firm combined? Which would handle all the requirements of a foreign investor’s property in Berlin?
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Don’t let the size of the investment distract you from the problems here, as we have plenty of examples of bigger investments with similar situations, I will quote one later on. Back to our little case study:
Paying off a tenant for moving out can be a commercially clever move as in most cases the value of a vacant apartment is significantly higher than a tenanted one. In most cases, the management account with the property manager will not have the necessary funds available (or there is something wrong with the cash management) but if the payment to the tenant is not funnelled through the management account there is the danger that the accountant will never know about it. I wonder what happened to the refurbishment cost in the case above. The suggested solution of a combined management company & accountancy firm would most likely not have solved the issue either unless there was a process in place involving the two and the owner.
Here is another example from our recent consultancy work:
We were representing a client’s interest in a malpractice court case against a property management. The owner received an invoice from his solicitor for an initial fee and filing cost for the court. He paid it from his private account, end of story. Had we not intervened the accounted would have never known about it and it would not have been included in the tax return. Especially painful as the reimbursement by the previous management company (we won the case) will be taxed as income.
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There are two very simple processes to choose from to avoid paying too much tax due to lack of appropriate processes and management by the owner:
- Funnel every single cost item through the management account. If there is not enough funding, provide it as you have to pay it anyway. If it is a reimbursement it will flow back to you straight away. There is no better documentation of the relevance for the investment. If your property manager is moaning about it, give me a call I will find a better one for you.
- Provide all relevant invoices and documents for your property directly to your accountant at the beginning of the year for the previous year and check back that everything has been considered and if not why.
Another option could be a service provider like an asset manager who knows your property and everything going on around it. A well-focused service specification could more than earn the fee related to the service.
Unsurprizingly this is a service we provide for our clients. The benefits go far beyond having everything included in your tax return: Most important is controlling the property manager in the client’s interest. Our cost benefit ratio is 25:75, meaning that our clients receive three times the benefit of our cost.
