What is depreciation (AfA) for real estate?

AfA stands for ‘depreciation for wear and tear’ and enables the acquisition or production costs of a depreciable asset to be spread over a normal useful life of several years for tax purposes in accordance with Section 7 EStG.

Depreciation for real estate (Section 7 (4) EStG) is basically intended to reflect the limited useful life of a property. Therefore, depreciation can only be applied to the building part, but not to the land part, as land does not wear out.

AfA can only be claimed for properties that are fixed assets. In the case of commercial property dealers or fix-and-flip transactions, the properties are classified as current assets for which no depreciation can be claimed. In principle, the depreciation of real estate is distributed evenly over the total useful life (straight-line depreciation).

What is the depreciation rate for property?

As a rule, depreciation for buildings held as private assets, buildings held as business assets that are used for residential purposes and buildings held as business assets that are not used for residential purposes and for which the building application was submitted before 01.04.1985 is 2% per year. If the building was completed before 01.01.1925, the depreciation rate is 2.5%.

To promote residential construction, the straight-line depreciation for buildings completed after 31 December 2022 was increased from 2%to 3% annually! This gives an incentive to invest into new built properties, as this decreases your taxable income – but does not stress your cash out.

Buildings held as business assets that are not used for residential purposes and for which the building application was submitted after 31 March 1985 are depreciated at an increased depreciation rate of 3%. A higher depreciation rate of 3% applies to non-residential buildings held as business assets, for example in the case of asset-managing real estate companies (vvGmbH). The asset-managing Immobilien-GmbH can be of interest to property investors due to the very low current taxation rate of only 15.825%. This structure only makes sense, though if you have properties north of 2M EUR. Below that threshhold the operating cost just exceeds the benefits.

What needs to be considered when allocating the purchase price?

The purchase of the property sets the course for the future level of depreciation. The purchase price must be divided between the land and the building. Thats either done by you, as the buyer at the time of the purchase agreement – or this is done while filing your taxes.

The tax authorities use an Excel tool published by the Federal Ministry of Finance to allocate the purchase price. This leads to low assessment bases for depreciation (AfA) for many properties. Particularly in the case of properties that are to be held in the portfolio for the long term, it is therefore regularly worth the effort to calculate the depreciation assessment basis independently.

How do refurbishments affect depreciation?

As a property owner, you should also – as a rule of thumb – avoid allocating the costs of refurbishing a property to the acquisition costs.

Expenses for repair and modernisation measures that are carried out within three years of the acquisition of the building are included in the (acquisition-related) production costs if the expenses, excluding VAT, exceed 15% of the acquisition costs of the building – not the total purchase price. As a result, the expenses are not immediately deductible, but can only be taken into account via the corresponding building depreciation – which obviously will want to avoid. Cash in hand now, is better than a 2% tax rebate over the next 50 years.

If major refurbishment work is planned after purchase, this should be carried out before buying the property if possible. In general, the 15% limit and the calculation are not as simple. This starts with the fact that subsequent acquisition costs can be incurred even if the 15% limit is not exceeded and ends with the interpretation of the definition of a building – getting close to this value will have some eager tax clerks have a very close look at the case and might just punish you… 

Special depreciation to promote the construction of new rental housing

Since 2023, new construction projects can once again be depreciated at a higher rate – provided they meet certain (energy) efficiency requirements. On application, new rental apartments can be depreciated at a depreciation rate of up to 5% in the year of acquisition or completion and in the three following years, in addition to the regular depreciation rate of 3%. The usual pro rata temporis allocation of depreciation is no longer applicable.

New apartments can be created by:

• New construction of detached, semi-detached or multi-family houses,
• the extension or conversion of existing building areas (in particular loft conversions, but also the division of living space, rezoning of commercial space)
• The addition of a storey or extension on or to an existing building (with expansion of floor space)

Another prerequisite for claiming special depreciation is the transfer of the property for third-party residential purposes in return for payment. An apartment does not serve the residential purposes required under Section 7b EStG if it is intended for temporary accommodation (vacation apartments, serviced apartments),

In addition, an upper construction cost limit must be adhered to. Special depreciation is only permitted if the acquisition or production costs do not exceed EUR 4,800/sqm of living space. If these are higher, the special depreciation cannot be claimed. However, the eligible portion of the acquisition or production costs is again limited to a maximum of EUR 2,500 per square meter of living space. This means that only part of the acquisition and production costs may be eligible for tax relief under Section 7b EStG. In addition to the special depreciation allowance, the regular depreciation allowance must be granted in accordance with Section 7 (4) EStG.

The subsidized apartment must be located in a building that meets the criteria of an “Efficiency House 40” with a sustainability class and this must be verified by the Sustainable Building quality seal.

In terms of timing, the special depreciation can only be claimed if the building application or the building notification (if no building permit is required) was or will be completed in the period from 31.12.2022 to before 01.01.2027.

Caution! In the year of acquisition and the following nine years, a separate declaration on the conditions of use must confirm that the apartment will continue to be used for residential purposes in return for payment. In the event of a sale – which is not subject to income or corporation tax – the special depreciation is reclaimed with interest. This also applies if the buyer continues to let the property for a fee.

Heritage Building depreciation (Denkmal AfA)

Owners of heritage buildings (Denkmalschutz) are particularly affected by the higher costs of their property, as the use and maintenance of listed buildings impose particular financial burdens on them. To compensate for this and as an incentive – a classic example of the control function of tax law), the legislator has created monument depreciation in accordance with Sections 7i, 10f, 10g and 11b of the German Income Tax Act (EStG).

In the case of heritage building depreciation, up to 9% of the costs for construction measures that are necessary in terms of type and scope to maintain the building as a monument or for its appropriate use can be deducted during the first 7 years and up to 7% in the following four years.

The buyer must be burdened with additional monument-related costs on his property, which is why the principle applies: “Buy first, then renovate.” This is particularly important when buying from a project developer.

Major exception: depreciation (AfA) for owner-occupied property. As the obligations and restrictions of monument protection also apply to owner-occupied residential properties, the legislator allows depreciation of 9% to be deducted over ten years as special expenses.

Depreciation for buildings in redevelopment areas and urban development areas

Modernization costs for buildings in redevelopment areas and urban development areas can be deducted at a rate of up to 9% in the year of modernization or maintenance and in the following seven years, and up to 7% in each of the following four years in accordance with Section 7h EStG.

The increased depreciation according to § 7h EStG requires a property-related certificate from the responsible municipality that has designated the redevelopment area and the urban development area. Please note that strict conditions apply to the certificate.

Conclusion

Depreciation (AfA) for real estate is a vital financial and tax consideration for property investors and owners in Germany. Understanding the nuances of AfA can significantly impact the tax benefits and financial planning associated with real estate investments. Whether it’s the basic depreciation rates for residential and non-residential buildings, the intricacies of allocating purchase prices, or the strategic planning around refurbishments and special depreciation options for new constructions and heritage buildings, every aspect requires careful attention. The recent increase in straight-line depreciation rates and the introduction of special depreciation allowances underline the government’s effort to incentivize investment in residential construction and energy-efficient projects. However, property owners must navigate the complexities of these regulations to maximize their benefits while complying with the legal requirements. As the real estate market continues to evolve, staying informed and consulting with tax professionals will be key to leveraging depreciation allowances effectively for long-term financial success.

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