Business assets or private assets? Tax classification of real estate

The tax classification of real estate that is used for both business and private purposes is a complex issue in practice that is often overlooked. Tax classification is particularly important in the case of mixed-use properties, as it determines the tax treatment of acquisition and production costs, depreciation and subsequent capital gains tax. In this article, you will learn what is important when it comes to the tax treatment of real estate as business assets and what consequences this has.

When does a property belong to taxable business assets?

If, for example, a building owned by a trader or self-employed person or a room therein is used exclusively and directly for the purposes of commercial operations or self-employment, these buildings (or parts thereof) together with the land on which they stand constitute taxable business assets.

Important: According to established case law and administrative practice, the use and functional connection of the respective part of the building is decisive for the income tax assessment of individual parts of the property. A building can therefore be divided into several independent economic assets for tax purposes if the individual parts of the building are used differently.

Mixed-use properties: division required

Real estate and parts of real estate that are used exclusively and directly for the property owner’s own business purposes are generally considered necessary business assets. If a single room is used both for business and private purposes, case law dictates that the extent to which the room is used for business purposes determines whether it is classified as business or private assets. This classification does not have to be actively declared, but is automatic based on the corresponding use.

The real estate is regularly allocated to business assets according to the use of the building. The ratio of the usable floor space of the part of the building used for business purposes to the usable floor space of the entire building is decisive for the allocation.

Important: Business assets can only exist if the self-employed or commercial operator is also the owner of the property. If, for example, a rented property is used for business purposes, it cannot be classified as business assets.

Example: Self-employed person uses space in a single-family home

The sole owner of a single-family home works as a freelance engineer and earns income from self-employment. He uses an entire room in his otherwise privately used single-family home for this purpose. This means that the space used for business purposes, including the floor space, constitutes business assets from the point at which it is used for self-employment, with all the associated tax consequences.

Exception for low business use

An exception applies to parts of real estate used for business purposes that account for less than 20% of the property value and whose value does not exceed €20,500. In this case, they do not have to be allocated to business assets – a (proportionate) deduction of costs is still possible.

Real estate as business assets: the tax consequences

Depreciation: For the part of the building used for business purposes, the acquisition or production costs may be taken into account as depreciation.

Operating expenses: The proportionate property expenses are deductible operating expenses for the purpose of determining the profit from the business activity. In the case of a home office, the deduction of costs may be excluded.

Tax on sale or change of use: As a rule, an undesirable tax effect is felt when the use of the part of the building for business purposes ceases. If the business is sold or the business activity is discontinued or the part of the building is no longer used for these purposes, the increase in value of the proportionate part of the land must be taxed. In particular, the increase in value of the proportionate share of the real estate can result in a significant income tax burden in these cases.

Please note: In these cases, a tax-free sale after 10 years is not possible, unlike for real estate held as private assets. However, under certain conditions, tax relief may apply.

Special case: transfer to a corporation: A similar problem that is relevant in practice can also arise if real estate is transferred to a corporation (e.g. a limited liability company) and the owner of the real estate or a group of persons owns the real estate and, in addition, the same persons are the majority shareholders of the corporation. In these cases, too, it is often overlooked that the real estate becomes business assets. The tax consequences of such a constellation are far-reaching.

Useful: Tax advice on the classification of real estate

The tax treatment of real estate and parts of real estate used for business purposes is complex and requires careful consideration of the use and the associated tax consequences. Real estate owners should be particularly aware of the regulations and tax consequences of classifying mixed-use properties as business or private assets.

Compliance with legal requirements and documentation of use are of central importance here in order to avoid subsequent tax disadvantages. In any case, individual advice on this complex issue should be sought for the examination of individual cases.