Design potential: Act on the Modernisation of Corporate Income Tax and Real Estate

Now that the Corporate Income Tax Modernization Act (KöMoG) has come into force, the question arises as to whether it makes sense to apply it to a real estate – GmbH & Co. KG (German joint stock association).

Retained profits of corporations managing real estate that are only engaged in rental activities are subject to a total income tax burden (including solidarity surcharge) of 15.83%, subject to the extended trade tax reduction. Even in the case of profit distributions, taking into account the distribution-related income tax burden, this results in a tax rate of 38.03% if the flat rate withholding tax can be applied, or 39.81% if the partial income procedure is applied at the top tax rate.

If no distribution is made, the liquidity advantage achieved by the low taxation (15.83%) can be used in the corporation, e.g. to more quickly repay the liability resulting from the acquisition of the property or to invest in the property or other properties. In principle, however, future capital gains on the real estate must be taxed in the corporation. However, taxation can be postponed by forming reserves.

The KöMoG has for the first time created the possibility of treating a partnership qualifying as a co-entrepreneurship as a fictitious corporation for income tax purposes by means of an option, without a “real” change of legal form having to be carried out under civil and corporate law. However, the regulations of the transformation tax law are applicable, so that the following must be observed:

-If the real estate is part of the joint assets of a co-partnership, it must be understood that by exercising the option a fictitious contribution of the co-partnership shares takes place in corresponding application of Sec. 20 UmwStG (German tax law on conversions). In this context, the regulations on book value continuation must be observed so that the transaction remains tax-neutral.

-If the real estate is part of the special business assets, it must first be transferred to the general business assets. However, the transfer must take place at the same time as the fictitious contribution of the co-entrepreneurial share, as otherwise the tax neutrality of the option is jeopardized. However, the exercise of the option triggers land transfer tax within the ten-year lock-up period of Sec. 5 (3) GrEStG (German tax law on acquisition of property).

-If the real estate is held as private assets, it must be transferred to the overall assets of a joint venture, which may allow tax-free depreciation potential to be leveraged. However, here, too, risks under real estate transfer tax law must be taken into account.

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