Depreciation on rental apartment buildings – how investors benefit from tax advantages

The conditions for the construction of new flats have become extremely difficult: rising material prices, high production costs and, most recently, a massive increase in construction interest rates are having a severe impact on residential construction. Nevertheless, investing in the construction of rental flats can still be worthwhile – tax depreciation options play a central role here.

For years, the government has been trying to support the real estate sector with subsidies and tax incentives. In addition to various KfW financing programmes, the tax deduction for wear and tear (AfA) allows the acquisition and production costs of a property to be deducted from tax over a period of years, thus reducing the owner’s tax burden.

What depreciation options are there? What is their financial impact? What regulations need to be observed?

Taxable income from rental and lease

The tax treatment of rental income is relatively simple: rental income counts as income, while the associated costs – such as interest, depreciation and maintenance – are deducted as income-related expenses. The remaining amount is the taxable surplus or loss.

Since many investors already have a high income from employment or entrepreneurial activities, their rental income is often subject to the top tax rate of 42% or 45%. In many cases, the solidarity surcharge is added, further increasing the tax burden. This makes targeted tax optimisation through depreciation and other tax advantages all the more important.

Acquisition or production costs as the basis of assessment

The depreciation for wear and tear is calculated on the basis of the acquisition or production costs. However, since the land portion is not subject to wear and tear, it is not depreciable. For this reason, the purchase price allocation must always be carried out for new-build flats.

In this case, the acquisition costs of a property are to be divided into a building portion (depreciable) and a land portion (not depreciable). This division can be carried out in various ways:

• With the help of the BMF’s purchase price allocation tool,
• by means of an expert opinion,
• or by a purchase price allocation in the notarial contract.

The method chosen can have significant tax implications, since a higher building share leads to higher annual depreciation and thus greater tax savings.

Straight-line depreciation

The most common method of depreciation for real estate is the straight-line method. This involves spreading the acquisition costs of the building evenly over a legally defined period of time.

From 2023, different depreciation rates will apply to residential property depending on the date of completion:

• Built up to 31 December 1924: 2.5% per year
• Built between 1 January 1925 and 31 December 2022: 2% per
• Built on or after 1 January 2023: 3% per

Straight-line depreciation is granted in constant annual amounts and remains unchanged over the entire depreciation period. This enables investors and property owners to plan their tax savings.

Degressive depreciation

Degressive depreciation is once again permissible under Section 7 (5a) of the German Income Tax Act (EStG) and offers investors an attractive opportunity to reduce their tax burden more quickly.

In the first year, it amounts to a whopping 5% of the acquisition costs and can be applied to newly constructed or newly acquired residential buildings that were purchased between 1 October 2023 and 30 September 2029. In subsequent years, the degressive depreciation is based on 5% of the residual value of the building part.

The advantage of the declining balance method of depreciation is that higher depreciation amounts can be claimed in the early years, reducing the tax burden sooner. This can be a valuable liquidity advantage for property investors, particularly in times of high financing costs.

Example calculation: new-build apartment as a capital investment – take advantage of tax benefits

To illustrate tax optimisation using a newly built apartment as a capital investment, we will look at a fictitious but realistic property development project.

Since new-build apartments are often purchased directly from the developer without paying estate agents’ fees, the additional costs are only around 5 per cent of the purchase price. The total purchase price is €600,000, including land transfer tax and notary fees.

Key data on the investment:

• Total acquisition costs: €600,000
• Building portion (75%): €450,000 (relevant for depreciation)
• Rental income (excluding heating and utilities): €1,500/month → €18,000/year
• Equity: €100,000
• Debt financing: €500,000
• Interest rate: 3.5% p.a. → €17,500 / year
• Repayment rate: 2% p.a. → €10,000 / year
• Depreciation: 5% degressive on building
• €450,000 × 5% = €22,500 / year (first year)

1. Cash flow before taxes:

The annual interest and amortisation payments are:
Interest (€17,500) + amortisation (€10,000) = €27,500

Since the rental income amounts to €18,000 per year, there is a shortfall of €9,500 per year.

2. Tax treatment – determination of income

Position	Amount (€ per year)
Income	18.000
– Interest (3,5 % on 500.000 €)	-17.500
– Amortisation (AfA 5 %)	-22.500
– Non-apportionable costs	-500
= Tax loss	-22.500

3. Tax advantage through loss compensation

This loss can be offset against other income. With an annual income of €150,000, the investor is subject to the top tax rate of 42% plus the solidarity surcharge (5.5% on income tax).

Tax advantage:
22.500 € × 44,3 % = 9.970 € per year

4. Cash flow after taxes:

The initial negative cash flow of €-9,500 is completely offset by the tax saving of €9,970.

Conclusion

The tax write-offs and interest costs ensure significant tax savings, whereby the investment develops positively despite initial underfunding. This strategy is particularly attractive for investors with high incomes, as they can convert income tax into asset growth and create an inflation-protected tangible asset investment in the long term.

If the construction cost ceiling of €5,200 per square metre of the building part is adhered to, particularly energy-efficient new buildings (EH 40 + quality seal for sustainable buildings) can also benefit from a special depreciation of 5% in the first four years.

It is generally advisable to check your individual options with a tax consultant in order to choose the best strategy for the property in question.