Tax depreciation

Tax Depreciation - Tax depreciation for real estate refers to the ability to claim the acquisition or construction costs of a building as income-related expenses or business expenses over its useful life. It reduces the tax burden and is one of the most important tools for real estate investors.

Overview of Depreciation Methods

The most important form of depreciation is straight-line depreciation (depreciation for wear and tear) under Section 7(4) of the German Income Tax Act (EStG). For buildings completed after December 31, 2022, the annual depreciation rate is 3 percent over a useful life of approximately 33 years. For older existing buildings constructed before 1925, a rate of 2.5 percent over 40 years applies; for buildings constructed in or after 1925, a rate of 2 percent over 50 years applies. Only the building is depreciated, not the land, as the land does not depreciate in value.

In addition to straight-line depreciation, the legislature has introduced declining-balance depreciation under Section 7(5a) of the Income Tax Act (EStG). For new buildings with construction starting in October 2023 and completion by the end of 2028, this allows for an increased depreciation rate of 5 percent in the first year, which applies to the remaining value in subsequent years. This method offers greater tax relief in the initial years.

Special depreciation under Section 7b of the German Income Tax Act (EStG) promotes the construction of new rental apartments with an additional 5 percent annually for the first four years, provided certain construction cost limits are adhered to. This allows for up to an additional 20 percent to be depreciated in the first four years, in parallel with regular depreciation.

Special regulations under Sections 7h and 7i of the German Income Tax Act (EStG) apply to listed buildings. Renovation expenses for historic buildings can be depreciated at increased rates over twelve years if the property is rented out: 9 percent in the first eight years and 7 percent in the following four years. Owner-occupiers can claim renovation costs for historic buildings as special expenses under Section 10f of the Income Tax Act (EStG), but only over ten years at a rate of 9 percent per year.

Section 35c of the Income Tax Act (EStG) offers another option: Energy-efficiency renovation measures on owner-occupied residential property are eligible for a tax credit totaling 20 percent of the expenses, spread over three years. This is one of the few tax benefits also available to owner-occupiers.

As a general rule: Regular building depreciation and special depreciation require that the property be used to generate income, i.e., that it be rented out. In the case of owner-occupancy only, the right to ongoing depreciation does not apply. The exceptions for owner-occupiers are limited to the historic preservation depreciation under Section 10f and the energy efficiency subsidy under Section 35c of the Income Tax Act (EStG).

What to Consider When Calculating

The tax basis for depreciation is the building portion of the acquisition costs. Since land cannot be depreciated, the purchase price must be divided into a building portion and a land portion. The tax authorities provide a worksheet for this purpose to assist with the purchase price allocation. Allocating as much as possible to the building portion is tax-advantageous. Subsequent construction costs, such as additions or major renovations, increase the depreciation base, while maintenance expenses, such as repairs and upkeep, can be immediately deducted as income-related expenses.

Practical Tip for Nuremberg and Franconia

The Nuremberg metropolitan region offers excellent opportunities, particularly for the historic building depreciation allowance (Denkmal-AfA). Nuremberg’s Old Town, Fürth’s Wilhelminian-style district, and the historic city centers of Erlangen, Bamberg, and Bayreuth feature numerous buildings under historic preservation. Anyone who purchases and renovates such a property benefits from the increased depreciation rates. The special depreciation allowance for new rental housing construction can also be attractive in growing areas such as Nuremberg-Südstadt or the harbor district, provided the construction cost limits are adhered to. We recommend reviewing the tax options early on with a tax advisor before making a purchase decision. We would be happy to connect you with suitable contacts in the region.

Frequently Asked Questions About Tax Depreciation

As an owner-occupier, can I claim tax depreciation on my home?

The standard building depreciation is only available to landlords. However, owner-occupiers can benefit from the historic preservation depreciation under Section 10f of the Income Tax Act (EStG) if they renovate a building designated as a historic landmark. In addition, Section 35c of the German Income Tax Act (EStG) provides tax incentives for energy-efficient renovation measures on owner-occupied residential property, with a tax reduction of up to 40,000 euros. These two exceptions make renovation tax-advantageous even for owner-occupiers.

How do I allocate the purchase price between the building and land components?

The allocation is generally based on the ratio of the market values of the building and the land. The Federal Ministry of Finance provides a guide based on the asset value method. A higher building share results in a higher annual depreciation. In case of disagreements with the tax office, an expert opinion can help justify a more favorable allocation.

Can different types of depreciation be combined?

Yes, within certain limits. Special depreciation under Section 7b can be claimed in addition to straight-line depreciation. However, simultaneous use of straight-line and declining-balance depreciation is not possible; the owner must choose one or the other. A later switch from declining-balance to straight-line depreciation is permitted, however. The historic preservation depreciation replaces the regular depreciation for the renovated portion but can run alongside the regular depreciation for the existing building portion.

What tax-related distinctions apply to maintenance expenses versus construction costs?

The distinction between immediately deductible maintenance expenses and construction costs that subsequently increase the building’s value is one of the most common points of contention between real estate investors and tax authorities. Maintenance expenses-that is, repairs and maintenance that preserve the condition but do not significantly improve it-are immediately deductible as business expenses in the year they are incurred. Construction costs, on the other hand, increase the depreciation base and must be depreciated over the building’s remaining useful life. The tax authorities classify measures as acquisition-related construction costs if they are incurred within the first three years after purchase and exceed 15 percent of the building’s value (excluding the land)-in this case, the immediate deduction is completely forfeited. For investors in the Nuremberg metropolitan region who purchase and renovate older buildings in need of renovation, this regulation can pose a significant liquidity trap. We recommend consulting a tax advisor before the purchase to review the tax treatment of all planned renovation costs and, if necessary, spreading out renovation phases over time to avoid exceeding the 15 percent limit.

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