Carve-out of real estate at partnerships – applicability of Sec. 6b GITA

published on 16 May 2024 | reading time approx. 3 minutes

Sec. 6b GITA plays a big role in the transfer and sale of real estate, as this provision can be used to avoid direct taxation of realized hidden reserves. However, a number of special key points must be taken into account when applying Sec. 6b German Income Tax Act (‘GITA’).

Importance of real estate in the sale of interests in a partnership

In transactions involving (medium-sized) partnerships, there are often cases in practice in which the partnership's real estate is not transferred for various reasons and should therefore be carved out of the partnership before the transfer of interests. In order to avoid any potential tax burden, the so-called reinvestment reserve in accordance with Sec. 6b GITA is a popular structuring instrument.

Consequences of recognising a Sec. 6b reserve

The withdrawal (without consideration) or sale of a property held as special or joint assets of a partnership results in the realization of a withdrawal or disposal gain. The withdrawal or disposal gain is the difference between the fair market value and the tax book value less any withdrawal or disposal costs incurred for the property, which is subject to income tax and trade tax. Sec. 6b GITA launches the possibility of avoiding the taxation of hidden reserves. Specifically, the statutory regulation provides for the following two options:

Deduction of realized hidden reserves from the acquisition/manufacturing costs in the financial year of the sale or the financial year preceding the sale of favoured assets acquired or produced, or
Creation of a profit-reducing reserve in the amount of the hidden reserves and their transfer in a later financial year.

The creation of a reinvestment reserve does not result in any direct taxation on disposal, but the transfer of the Sec. 6b reserve reduces the acquisition/manufacturing costs and therefore the depreciation base of the reinvestment asset. This leads to a reduced depreciation volume in the years of depreciation and, due to the lower depreciation, to a higher taxable profit in these years. In addition, any capital gain of a subsequent sale of the reinvestment asset is higher due to the lower acquisition/manufacturing costs.

Requirements for the formation of a Sec. 6b reserve

The following conditions must be met cumulatively for a transfer of hidden reserves to be considered:

Disposal of certain favoured assets (including land and buildings in particular),
Six-year belonging of the assets sold to a domestic permanent establishment,
Formation of a capital gain upon the sale of this asset that is taxable in Germany,
Determination of profits by operating assets comparison, i.e. financial accounting,
The reinvestment assets belong to the domestic business assets and
Traceability of profit transfer in the accounts.

The disclosed hidden reserves can be transferred tax-neutrally to the following favoured assets:

Land and property, insofar as the gain arose on the sale of land and property,
Buildings, insofar as the gain arose on the sale of land and property and/or buildings.

The so-called reinvestment period for the transfer of the reinvestment reserve to the acquisition/manufacturing costs of favoured assets begins at the end of the financial year in which the reserve was formed. This period is four financial years and is extended to six years in the case of transfers to newly constructed buildings if the construction of the building was started before the end of the four-year period.

It should be noted that a reinvestment must actually be made. If the Sec. 6b reserve is not subsequently transferred to a reinvestment asset, the reinvestment reserve must be released after the reinvestment period has expired, increasing profits. This reversal amount is also subject to interest of 6% for each full financial year in which the reserve existed.

Special features of the Sec. 6b reserve for the sale of partnerships holding real estate

The transfer of the reserve is not limited to reinvestment assets that are part of the special or joint assets of the partnership in which it was created and in which the co-entrepreneur's share is sold. As the reinvestment reserve is co-entrepreneur-related, it can also be transferred to favoured business assets that are part of

another business run as an individual enterprise,
the special business assets of the co-entrepreneur (at this or another partnership), or
the joint assets of another partnership and are attributable to the co-entrepreneur,

to the extent that the gain is proportionately attributable to this co-entrepreneur.

The creation of reinvestment reserves can be a useful structuring instrument to avoid the immediate taxation of gains from the sale of property. However, the advantage of later taxation should be compared to the possible disadvantages (in particular, reduced depreciation volume). The requirements for the creation and transfer of a reinvestment reserve and the incurrence of real estate transfer tax on the transfer of a property should also be examined on a case-by-case basis. Last but not least, the consequences of a possible non-transfer of the Sec. 6b reserve to a reinvestment asset, in particular the additional burden due to interest, should also be taken into account in the decision process.