Tax tip: Combat housing shortage with special depreciation allowances

Tax incentives for property investments could alleviate the acute housing shortage. One key measure here is to improve special depreciation allowances for residential construction. These special depreciation allowances already exist under Section 7b of the German Income Tax Act for the construction of new rental flats. However, a recent case before the Cologne Fiscal Court shows that the application of these regulations is not always easy (case no. 1 K 2206/21).

An owner had demolished a rented residential building that was built in 1966 and replaced it with a new building on the same site. Extensive renovation work would have been required on the residential building, including the replacement of the sewage pipes. In view of the high renovation costs of more than 100,000 euros, the property owner decided in favour of demolishing the old building and constructing a new one. He assumed that he would be able to claim the production costs of the new building for tax purposes as part of the special depreciation allowance. He applied for special depreciation for the construction of the new rental flat, but was refused by the tax office. The reason: According to Section 7b of the Income Tax Act, new living space must be created, which was not recognised in this case. The owner therefore brought an action before the Cologne Fiscal Court.

Special depreciation allows the costs of a building to be written off as income-related expenses more quickly than usual. For newly constructed residential properties, Section 7b of the Income Tax Act currently allows the acquisition or production costs to be depreciated at five per cent in each of the first four years, subject to further conditions. In addition, the regular statutory depreciation of either three per cent of the building costs on a straight-line basis or five per cent on a declining balance basis can be claimed. This means that 32 per cent to almost 40 per cent of the building costs can be claimed for tax purposes within the first four years. The land is not depreciable. For example, with building costs of 250,000 euros and a tax rate of 40 per cent, up to 40,000 euros in income tax could be saved in the first four years.

In its judgement of 12 September 2024, the Cologne Fiscal Court ruled that the newly built single-family home did not constitute a new, additional dwelling, as it merely replaced an old one with a new one. This does not fulfil the legal objective of creating new living space. The plaintiff's objection that there was temporarily no house on the property due to the demolition and that new living space had therefore been created was not accepted by the tax court.  Furthermore, the residential unit was neither technically nor economically used up at the time of the demolition, meaning that a new building was not absolutely necessary.

An appeal against the judgement has been lodged with the Federal Fiscal Court (case no. IX R 24/24). It remains to be seen whether the Federal Fiscal Court will confirm the decision of the tax court.