General information on renting between relatives
The basic prerequisite for the recognition, for tax purposes, of rental relationships between close relatives is that the rental agreement has to have been concluded effectively under civil law. Furthermore, the content of the agreement and its execution have to be in accordance with the terms and conditions that would be usual between unrelated parties. The starting point for determining the relevant rent has to be the average market rent for the local area for residential properties of comparable type, location and fit-out.
If the consideration paid in return for providing a domestic property for residential purposes is less than 66% of the average market rent for the local area then the provision for use of the property has to be divided up into remunerated and non-remunerated portions. This in turn means that, for tax purposes, the allowable expenses will not be fully recognised but, instead, only on a pro rata basis.
Determining the average market rent for the local area
Consequently, in order for the rent to be recognised for tax purposes it is crucial that the level does not fall by an excessive amount below that of the so-called average market rent for the local area. This average has to be understood as the net rent - exclusive of heating, lighting and other service costs - in the local area for residential properties of comparable type, location and fit-out, taking into account the ranges in the local rent index plus the apportionable costs. The average market rent for the local area should generally be determined on the basis of the local rent index. This was expressly clarified by the Federal Fiscal Court (Bundesfinanzhof, BFH) in its ruling from 22.2.2021 (case reference: IX R 7/20).
Should no rent index be available then, according to the BFH, there are other equally valid options for determining the rental level in the local area, namely,
- an appraisal by a publicly appointed and sworn expert,
- information from a rent database, and
- the rent levels for at least three comparable residential properties.
Use can also be made of these three options if a rent index is indeed available but has not been updated for market developments, or if it is the case that the let property is a special property.
Individual cases do not constitute reliable benchmarks
According to the BFH, the average market rent for the local area may not be determined solely on the basis of the rent paid by a third-party tenant for a residential property in the same block. This is because the average rent for the local area should constitute an objective benchmark for the residential properties in a town or municipality and should be determined by taking into consideration a broad spectrum of comparable residential properties in the respective location.
Conclusion: In its above-mentioned ruling, the BFH distanced itself from its previous opinion with respect to determining the average market rent for the local area. This ruling will be particularly important for those cases where the average rent for the local area was determined solely on the basis of a single property rented to a third party and, as a consequence, the deduction of allowable costs without any reductions was refused due to the lack of full rental payment.