Production costs

Construction Costs - For tax purposes, construction costs include all expenses that expand a building, substantially improve it beyond its original condition, or bring it into an operational state. Unlike maintenance costs, which are immediately deductible, construction costs are depreciated over the building’s useful life (AfA).

Distinction from Maintenance Expenses and Tax Treatment

The distinction between construction costs and maintenance expenses is one of the most common and, at the same time, most significant issues in real estate tax law. Maintenance expenses-that is, measures that merely maintain a building in proper condition or restore it to its original condition-can be fully deducted as income-related expenses or business expenses in the year of payment. Construction costs, on the other hand, are added to the acquisition or construction costs of the building and depreciated over the regular useful life-typically 50 years for residential buildings at a rate of two percent annually (Section 7(4) EStG).

According to the case law of the Federal Fiscal Court, construction costs apply in particular in three cases:

• Expansion: The building is enlarged by new components, such as an addition, an upper story, or the installation of a previously nonexistent dormer window.
• Significant improvement beyond the original condition (standard upgrade): At least three of the four key systems-heating, plumbing, electrical, and windows-are upgraded to a significantly higher standard within a short period of time.
• Making the building operational: A building is brought into a usable condition for the first time, for example, when a shell is completed or an unusable ruin is renovated.

Of particular relevance is the so-called 15-percent limit (Section 6(1)(1a) of the Income Tax Act): Expenses for repair and modernization measures incurred within the first three years after the acquisition of a building and exceeding a total of 15 percent of the building’s acquisition cost (excluding land) are mandatorily treated for tax purposes as acquisition-related construction costs-regardless of whether they are materially maintenance or construction costs. Annual transition periods or cosmetic repairs within the usual scope are excluded.

Depreciation and Economic Impact

Economically, construction costs mean that for landlords, the tax relief is spread over many years rather than taking effect immediately. For a renovation costing 200,000 euros that is classified as construction costs, the annual depreciation allowance is only 4,000 euros (two percent). If the same amount were classified as maintenance costs, it would result in a full deduction for income-related expenses in the tax assessment year. For this reason, we recommend that owners have planned renovations reviewed for tax purposes in advance and, if necessary, structure the work so that individual trades can qualify as maintenance expenses-for example, by spreading the construction work over a period exceeding the three-year limit.

Practical Tip for Nuremberg and the Metropolitan Region

In the Nuremberg metropolitan region, numerous residential buildings from the post-war period and the 1960s through the 1980s are in need of renovation-particularly in neighborhoods such as Gostenhof, Gibitzenhof, or Schweinau. Anyone who purchases such a property as an investment and comprehensively modernizes it should keep a close eye on the 15-percent limit for acquisition-related construction costs. We recommend working with a tax advisor to create a renovation roadmap before the purchase and, if necessary, staggering the construction work over time. This helps avoid a situation where maintenance expenses that are actually immediately deductible are reclassified as construction costs solely because of the three-year limit. For historic buildings-such as those in Nuremberg’s Old Town or in Fürth-increased depreciation rates under Section 7i of the German Income Tax Act (EStG) also apply, which can significantly mitigate the economic disadvantage of a classification as construction costs.

Frequently Asked Questions

When is a renovation considered a standard upgrade and thus classified as capital expenditure?

A standard upgrade occurs when at least three of the four key systems-heating, plumbing, electrical, and windows-are replaced within a short timeframe, thereby significantly increasing the building’s utility value. For example, if the old night storage heater is replaced with central heating, the bathroom is completely modernized, and the electrical system is brought up to current standards, the tax office generally classifies the entire project as a capital expenditure.

What happens if I exceed the 15 percent limit within three years?

All repair and modernization costs incurred within the first three years after purchase are added together. If they exceed 15 percent of the building’s acquisition cost (excluding the land), all expenses are treated as construction costs incurred shortly after acquisition and must be depreciated over the useful life of the asset. The only exceptions are expenses for additions and maintenance work that typically occurs annually.

Can I retroactively reclassify construction costs as maintenance expenses?

No, the tax classification is based on the objective characteristics of the construction project at the time it was carried out. Retroactive reclassification is generally not possible. Therefore, forward-looking planning is crucial: In many cases, by strategically staggering the timing or limiting the scope of work carried out simultaneously, it is possible to prevent maintenance expenses that are actually deductible from being reclassified as construction costs.

What are the tax rules for energy-efficiency renovation measures?

Since 2020, energy-efficiency renovation measures on owner-occupied homes can be deducted directly from income tax under Section 35c of the German Income Tax Act (EStG)-regardless of whether they are classified as construction or maintenance expenses. This rule does not apply to rented buildings; here, the distinction between immediately deductible maintenance expenses and construction costs to be spread over the useful life remains decisive. Anyone renovating a multi-family home in Nuremberg to improve energy efficiency-for example, by insulating the exterior walls, installing new windows, and adding a heat pump-cannot invoke Section 35c of the German Income Tax Act (EStG) and must therefore carefully assess whether the measures exceed the threshold for standard deductions. In addition, we recommend incorporating KfW subsidy programs (such as BEG subsidies for individual measures) into your financing plan at an early stage, as subsidies can significantly reduce the financial burden.

Practical Example: Renovation of a Post-War Apartment in Nuremberg

An owner purchases a condominium built in 1962 in Nuremberg-Gostenhof for 220,000 euros (of which 180,000 euros is the building share). Within two years of the purchase, he invests 35,000 euros in a new heating system, a modern bathroom, and electrical work. That is 35,000 euros out of the 180,000-euro building share, or about 19.4%-and thus more than the critical 15%. All renovation costs qualify as acquisition-related construction expenses and must be depreciated over 50 years. If the owner had spread out the work and only renovated the bathroom and electrical system in the first year (25,000 euros = 13.9%-just below the threshold) and replaced the heating system only in the fourth year after purchase, a portion would have been immediately deductible as maintenance expenses. This example shows how important advance tax planning is for renovations.

Back to the Real Estate Glossary.