Extended trade tax reduction: Sale of real estate free of trade tax

published on 21 December 2022 | reading time approx. 3 minutes

The tax burden is often decisive for the total return on investment in real estate. Apart from the tax on ongoing (rental) revenue, the tax levied on capital gains is the decisive factor in most cases amid the rising real estate prices. Skilled structuring which uses extended trade tax reduction allows limiting the tax burden to the level of an attractive corporate income tax rate (of about 15.8 per cent), also in a situation where the “last real estate” (of a real estate company) is sold during the year.

Extended trade tax reduction trade tax as starting point

From the tax point of view, it is often advantageous to hold real estate in a corporate com-pany structure. The reason is that revenue from real estate is only subject to corporate income tax (about 15.8 per cent) and not to trade tax. As long as profits are not distributed at the private level, this results in an attractive tax rate.

Given the policy-makers' current considerations on abolishing the possibility of tax free sale of real estate held as private assets, these structures are likely to become even more attractive.

This is due to the so-called “extended trade tax reduction” according to Section 9 no. 1 sentence 2 et seq. of the German Trade Tax Act [Gewerbesteuergesetz, GewStG]. This provision of the Trade Tax Act provides that income subject to trade tax should be reduced by the amount of income received from the management of own real estate. Thus, it is possible to achieve that rental income and income from the sale of real estate will not be subject to trade tax at all.

This requires, amongst others, that only immovable property is rented. “Harmful” is therefore in particular the provision of commercial (additional) services. The lease of other items, in particular of movables such as operating facilities is also harmful, as a rule. An exception from this principle is in particular the materiality threshold, introduced by law in 2021, below which revenue is considered not to be harmful. According to this provision, revenue earned on the basis of direct contractual relationships with the tenant of immovable property is considered “not harmful” if it does not exceed 5 per cent of the revenue earned from leasing the whole building.

The problem in terms of trade tax

The above-mentioned prerequisites for benefiting from the extended trade tax reduction involve yet another element – namely timing. The prerequisites must be met throughout the entire (tax) assessment period. Thus, on the one hand, the purchase of real estate during the year could be a problem since extended trade tax reduction may not be used if a purchase relates to the “first” real estate to be owned by the company. On the other hand, in particular the sale of real estate during the year also involves a number of tax pitfalls. This is because after the sale of the “last” real estate the company is no longer engaged exclusively in real estate management but only manages funds received as the purchase price.

The crucial issue from the tax perspective is therefore to maintain the availability of extended trade tax reduction also in the case of sale.

How trade tax exemption can still be ensured

In practice, several methods of structuring have been developed to prevent sales proceeds from becoming subject to trade tax. The most important ones are as follows:

The simplest way to avoid the levy of trade tax is shifting the transfer of possession of the real estate to the end of the financial year (e.g. 31 December). The question of whether this is possible should be discussed with the respective contractual partner (potential buyer).
Alternatively, another rather simple structuring option can come into consideration: The seller ensures that it is not the “last” real estate that is being sold. This is done by buying another piece of real estate in due time. In this context, the purchase of an economically subordinate, small real estate could be considered. In doing so, it is made sure that the company's lease activity does not stop.
Another possibility would be to modify the financial year in such a way that it ends at the time when possession is transferred. It should be noted, however, that this measure requires approval of the tax office – which does not necessarily have to be granted for modifications that are purely tax-motivated. Moreover, practical problems regarding the right timing might occur.
Last but not least, various transactions based on company law (in particular transformations) can bring about the result that the financial year or the existence of the company as a legal or tax entity will end at the time when possession is transferred. Also here, by way of appropriate planning, the seller can ensure that extended trade tax reduction is still applicable.
Another important issue relates to the above-mentioned materiality threshold below which revenue is considered not to be harmful. If the threshold is complied with, (ongoing) lease of plant facilities to a small extent will not be harmful. But if such real estate is sold, as a rule, these plant facilities will cause the refusal of extended trade tax reduction. This applies regardless of whether real estate is sold during or at the end of a financial year. Therefore, it should be ensured by way of appropriate structuring that such plant facilities are not sold together with the real estate and, in particular, not in the same financial year as the real estate.

Conclusion

As a result, it is economically very important that extended trade tax deduction is still available to real estate companies also in a situation where real estate is sold. With some tax planning, this goal can usually be smoothly achieved.

It seems that the issue poses a “problem” rather to the sell-side. But also the buyer of real estate should keep an eye on the issue of extended trade tax reduction. On the one hand, it is reasonable to choose already at the purchase stage a structure that ensures the availability extended trade tax reduction. On the other hand, also the tax situation of the seller is important to the buyer. This is because, as the case may be, he might be held liable for possible payments of (back) taxes resulting from subsequent refusal of extended trade tax reduction.