Many real estate buyers first look at the tax advantage which they would attain by purchasing the property. But in this regard a lot of grave mistakes have been done. The main one: not to consider what the property costs without tax advantages at the end, namely when the high tax advantages are depleted. Because: saving taxes might be good but should not be done at any price!

Some basic data are:

  1. You will not be able to save more taxes than you need to pay.
  2. The higher the tax advantage the higher usually is also the future liability.
  3. Money gained by tax advantage should be used for the property itself and not flow into the consumption.

So how should one deal with the subject of taxes 
and what mistakes should one avoid by all means?


First of all we need to consider that in our country we have a tax system which, in regards to the income tax, favours the less-earning ones more than the so-called top income level. If one, as a single, earns more than 120.000 DM per year which he needs to pay taxes on, one pays the highest possible tax percentage. This is not a rate of 50% or more however. Example: a single with an annual taxable income of 120.000 pays an income tax of exactly 43.807 DM in the year 1997, not including the church tax but including the solidarity surcharge. That is 36,50 per cent. If he is married and if both marital partners get assessed together then they pay “only” an income tax of 31.007 DM, meaning 25,83 per cent.

Not so with the so-called top earners; a single for instance with an annual taxable income of 350.000 DM needs to pay at least 134.000 DM of income tax – meaning 38,52 per cent. But here you have a very special effect: everything from his income above the border line of 120.000 DM gets charged with the maximum tax rate of 53%. Thus tax patterns generally aim at giving the guy a high tax advantage in order to then reduce the taxable income above a level of 120.000 DM. This whole thing makes it attractive especially to top-earners to participate in patterns with high tax deductions or advertising costs.

But the so-called “average earners” are doing less against the tax burden: a single who has an annual income of 50.000 DM and “only” needs to pay 11.893 DM of income tax usually contents himself with filling in the annual wage-tax adjustment and hardly even thinks about being able to change part of the taxes into funds.

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And exactly this brings us to the catchword: what’s essential is not thinking of saving taxes. What’s essential is the idea to, instead of paying taxes, at least invest part of the (otherwise lost) money into building one’s own wealth. In other words: instead of setting aside a certain amount for the tax office each month one invests part of it into e.g. a rented out freehold flat. Over the years this property builds up a considerable asset, and if one is smart one buys another flat on top of it every couple of years.

From where does the tax saving of a property come from now? Basically it is founded on the state’s intention to assist the creation of living space. And: if one offers residential space to others for rent one does it with the intention to gain income from it. Since every activity connected to income has its price, these costs can be deducted at first before the gain from this type of income gets subjected to a tax.

Furthermore the state has settled exactly what can be considered deductible costs when purchasing rented out living space. These are, first of all, all so-called advertising costs as well as certain expenses for maintaining the residential space and for the house administration. In order to make the calculation easier the government has also introduced lump sums for the deductions. Additionally the so-called disagio can be deducted as advertising costs, but only in the year of the purchase (a disagio is a deduction when the financing loan is being paid out; in exchange for it the bank has notably lower interest). Interests for a financing loan are also advertising costs and can thus be deducted.

Additionally, living space can be deducted just as any other economic good. With every year the value of a property lessens, in the eyes of the state, by at least 2 per cent; buildings which have been built before the 1st January 1925 even by 2,5%. New buildings can (up to now) be deducted with 5% at the beginning but are often much more expensive when purchased than existing real estate properties.

From all these components one calculates the amount to be paid to the tax office, which logically is much higher in the year one purchases the property than in the years after. So it is that very sum which can be deducted from the taxable income. And this is where the calculation errors enter in to a lot of investors: because the tax advantage is supposed to be very high in the year of the purchase they e.g. take a disagio of 10%. This however lengthens the back payment or raises the amortization rate. In the year of the purchase one may be able to mark up a large financial advantage, but in the years thereafter the property will feature quite a funding gap. In other words, the rents will lie way below the interest and additionally to this one still needs to pay the amortization, property reserve funds and the house administration.

Also patterns which offer a high percentage of depreciation in the first year (e.g. special depreciation in the east) are to be regarded with careful attention: often the tax advantage has partially added to the sales price of the property here. If one then also includes exorbitant rents (or sometimes even unreal rent guarantees) into ones calculation then the calculation in the years thereafter can be a complete flop. For no matter how high the attained tax advantage is: the investments done for this are commitments for which one pays interest and which also need to be paid back bit by bit.

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So in case of purchasing a freehold flat always calculate in a way that the monthly underfunding in the coming years, including the amortization, are not more than 300 to 500 DM. BEFORE TAXES – meaning before including the tax advantage into your calculation. That is the amount which one should anyhow invest into the private retirement provisions.

Here we give an example of a calculation in order to illustrate the above:

Mr. Example is married and, together with his wife, has an annual taxable income of 75.000 DM. Including solidarity surcharge they pay 15.400 DM income tax.

Example A:

The couple purchases a 1-bedroom apartment, sales price 130.000 DM, current rental income 550 DM. it is not a new building.

The purchasing couple finances this with a 5-year fixed interest rate, a 5%-disagio and 5,25% interest. The invested own funds are 15.000 DM.

In the year of the purchase the couple saves around 4.000 DM of taxes. In the years thereafter it is around 1.200 DM per year. That might not be very much but in exchange the monthly costs for interest, house administration and savings, after taxes, are only about 20 DM. The charge before taxes is around 120 DM. they pay off 108 DM per month to the loan (1%). That means they pay a total of around 228 DM per month for their freehold flat and get around 100 DM back from the state. But they anyways had 300 DM planned for their private pension plan for a permanent insurance; so the amount they pay for their property is not an additional liability. And: they take advantage of the fact that the property forms a constantly increasing asset value.

Example B:

Salesman B offers them the following property:

Sales price 280.000 DM, current rental income 980 DM. the financing data are identical with the first example, the only difference is that their own funds used are 30.000 DM. In the year of the purchase the couple saves around 9.300 DM of taxes. In the years thereafter it is around 3.800 DM per year. The monthly underfunding is 312 DM in this case, even 675 DM before taxes.

Conclusion: the property is too expensive: it would be better if our couple starts off in a small way and buys another property at a similar price the next year.

Example C:

Dr. A is a lawyer and earns 200.000 DM per year. Since he is married he pays around 66.000 DM of income tax. He purchases a property that needs refurbishment, in one of the new federal states, with a potential tax deduction possibility of 40% in the year of the purchase.

Sales price including refurbishment: 600.000 DM
Living space: 175 m²
Future rental income: 2.000 DM
Refurbishment costs: 400.000 DM
Deductible in the year of the purchase: around 200.000 DM

That means: in the year of the purchase Dr. A saves 66.000 DM of taxes. So far so good.

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If he invests these 66.000 DM into acquisition as his own funds then the calculation in the following years, with the same conditions, looks like this:

Expenses without amortization before taxes: 871 DM.
After taxes: 23 DM.

Since there is a high underfunding before taxes of course there also is a high tax advantage at this income level. But what if Dr. A wants to save taxes again in the next year and the year after and again calls upon patterns with high deductions or advertising costs in the year of the purchase, and thus builds up a potential underfunding year by year? Right: some day the whole thing becomes a time bomb! And now comes the actual point:

All financings presented here are fixed for a time period of five years (meaning the interest rates stay the same for five years no matter how the general interest level develops). Since the property has been financed by disagio one hasn’t paid back much of the total sales price of the property (usually one pays back 1% per year). This means after 5 years the refinancing looks like the following:

Example couple A: 124.700 DM to be refinanced
Example couple B: around 267.000 DM to be refinanced
Example lawyer C: 579.000 DM to be refinanced

Let us now assume in all examples that the interest rate has increased to 8% by then. The rents have also increased, but (as it can be expected) they have increased less in the new federal states than in the old ones. Then one gets the following picture:

Example A: monthly rental income 650 DM, interest is 847 DM per month. Underfunding: 197 DM
Example B: monthly rental income 1.080 DM, interest is 1.780 DM per month. Underfunding: 700 DM.
Example C: monthly rental income 2.275 DM, interest is 3.860 DM per month. Underfunding: 1.585 DM.

And now imagine in all the above examples the involved would not just have bought one property but three or four, based on the same pattern! You will easily be able to calculate who can bear the higher interest and who doesn’t. And on top of this: it is easier in good locations to transfer an increase of the interest rate to the rent than in weak ones.

Even if the couple in example A would have bought two apartments based on the same pattern they would only need to bear an underfunding of around 400 DM now. Allowedly, they have saved less tax this way, but on a long term have taken the better step. For they can either keep their apartments or sell one or more of them as usual in the market. They complete the whole engagement with a gain.

But how about the tax pattern of the lawyer in example C? He has to pay a high price for the taxes which he saved many years ago. You think he should then just sell the property? Since numerous of similar patterns have been applied in the new federal states our lawyer can get a maximum sales price of 450.000 DM, for there will be a large offer on the market. This means he has a loss of around 200.000 DM, which he needs to get back elsewhere, because the loan needs to be paid back in full when the property is getting sold!

Thus the following is essential:

Saving taxes might be sensible but should always be done with visual judgement. What is more important on a property is the long-term secure profitability.

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