How to tax rental income from property and is it still better to invest in a stock index?

Equity markets have seen their biggest decline since the financial crisis in 2007-2009. The Dow Jones, one of the best-known indicators of the US stock market, fell by around 15% in one week. This compares with a 34% fall in the whole of the crisis year 2008. These figures should, of course, be taken with a large grain of salt, but for the purposes of the need to ride the wave of hysteria, they serve well. In fact, to complement the classic, there is an emotion in numbers like these that is more interesting to the addressee than fact.

The fact is, among other things, that in a broader time span (for example 2008), corrections are naturally included. And you just don’t have those in a few day “equity rout” and so it looks more dramatic (EDIT: 2.3.2020 the stock market had a significant correction).

A few months ago, I offered readers my financial-tax perspective on the difference between investing in real estate and a traditional passive stock ETF (How to Tax Rental Property Income and Is It Still Better to Invest in a Stock Index?) In all years studied, the stock index came out the winner. In the context of the current stock slumps and the increased number of our clients investing as FOs or POs renting out Bratislava apartments, in this blog I will try to summarize the basic tax-legal rules of renting out real estate.

Letting of immovable property by a natural person

A natural person is normally able to rent out the property and achieve the so-called. passive income or active income. Passive income is a passive gainful activity that does not show signs of active participation of the landlord in the creation of the content of the services supplied (e.g.: the landlord does not change the linen or invoice the utility costs). If this content is partly created by the natural person, it is a business for which it is obligatory to obtain a trade licence.

Passive income of a natural person

This basic legal definition also has tax-tax implications. In the case of passive rental property, an individual’s income is subject to a fixed 19% tax rate, while if his tax base, together with the tax base on employment and other income, exceeds EUR 37,163 (note, effective from 2020), the tax rate is 25%. As this is passive income, the FO cannot take advantage of deductions from the tax base or the tax bonus, which in certain circumstances can significantly reduce the FO’s tax liability. Hence, this puts the landlord at a disadvantage compared to an active lease. However, the possibility to exempt such income from income tax up to an amount of EUR 500 is a certain tax advantage. However, in such a case, the tax expenditure must then be reduced proportionately.

In general, income from passive activity is not subject to health or social security contributions. Of course every system needs to have exceptions. For us, this exception is, for example, some old dividends, which are subject to a 14% health insurance premium, or some income from capital assets or other income, which is also subject to a health insurance premium. However, rental income is not subject to either health or social insurance, which is a significant advantage for many landlords.

For this type of letting, it is sufficient to register for a VAT number if it has not already been allocated to the landlord on another occasion. The landlord can only use real costs and may or may not have the property classified as a business asset. Whether it is worthwhile to have a property listed as a business asset is very individual (the amount of depreciation, the existence of a mortgage, the intended action with the property, the landlord’s individual position, etc.) and this assessment is the subject of a service called tax optimisation. The variety of such scenarios is enriched by the variant in which the landlord has the property in BSM.

If the landlord does not have the property classified as a commercial property, he can only include some real expenses in his tax expenses, such as utilities, property management, internet, or movables (if agreed in the contract with the tenant). However, if the landlord had the property included in business property, this range of possibilities to reduce the overall tax liability would be extended , for example, to include the aforementioned depreciation, any technical appreciation, interest or taxes and insurance.

Active income of a natural person

This income is governed by the standard tax and levy rules as a trade. You can read what taxes and levies a sole trader pays and what legal pitfalls a sole trade entails in another blog here or watch the video blog directly here and here. If we were to simplify it, a big advantage of renting through a trade is the possibility of claiming flat-rate expenses, non-taxable parts of the tax base or a tax bonus. In addition, from 2020, a landlord can benefit from a 15% income tax rate and also this income is not cumulated with some other income in one tax base, reducing the chances of the 25% tax rate being applied.

The disadvantage is that the income from the trade enters into the assessment base for the calculation of health insurance and, if certain conditions are met, also social insurance. The resulting tax-tax amount may thus be higher or lower than in the case of passive renting.

Lease of real estate by a legal person

What the tax-tax implications are associated with renting out property through a PO are equally shown in the above blogs.

In addition, for a legal entity, it is often requested to know whether it is possible to claim a VAT deduction on the purchase of, for example, an apartment. In most cases this is not possible due to a relatively recent amendment to the VAT Act, but there are exceptions where the law and the case law of the CJEU allow it. If the client claims a VAT deduction, they will have to account for some VAT on the output. There are exceptions here as well and the amount of output VAT can be modelled within the limits of transfer pricing for both income tax and VAT purposes.

Sale of property and income tax

Selling an apartment as an FO is, but also not more profitable. If the FO owns the property for more than 5 years and also has had it out of business property for more than 5 years (if it has had it listed), the income from the sale of the property is exempt from income tax. Otherwise, it falls under other income and the gain on the sale (= difference between the sale price and the purchase price or tax residual value) is subject to 19% or 25% income tax and 14% health levy.

In the case of a corporation, income from the sale of real estate is always subject to income tax at a tax rate of 15% or 21%. The taxable amount of the sale is calculated as the difference between the sale price and the taxable residual value, whereas if the subject of the sale is land, it is not depreciated for income tax purposes and its taxable residual value is equal to its purchase price.

Tax optimisation

In practice, I see clients having the flexibility to model their activities so that at the end of the day, even in combination with other activities of the client or their companies and the opportunities provided by the law, this represents a more tax-efficient tax burden. It’s fundamentally a simple tax or levy optimisation, which is both fully legal and legitimate. It is important to note that tax laws are not neutral = they do not provide only one solution to an economic cause, and therefore any fitting of a certain economic situation into some other tax frameworks cannot automatically be seen as tax avoidance. If you are interested in this topic, I recommend my blog “What can the Paradise Papers have to do with an “escheat” or a trade?”

So is it better to invest in a stock index?

In a previous blog, I was very clear about my preference for investing in a stock ETF rather than, for example, figuring out the structures for a full VAT deduction when buying a property for investment purposes and/or worrying about furnishing and renting. Apart from the fact that it has always worked out better financially so far, it saves time, adds to life’s comforts and also works out better from a tax point of view. My conviction was reinforced by a subsequent experience when on 25.12.2019 at 1:30 in the night (and therefore quasi on Christmas Eve) a radiator burst in the flat (about 10 years old new building) that I rent and was empty at that time. I flooded 4 floors below the apartment…

Paradoxically, however, this January I just sold part of my stock funds so that I could also buy an apartment in a new building in Bratislava. In my defence, I will add that I did not buy the flat for rent, but for my grandmother from Handlová, where, admittedly, she has lived a real life so far, and I would like her to live the autumn of her life unrealistically. I have thus neatly avoided the coronavirus. On the face of it, a “smart decision” (albeit completely accidental). But if I didn’t have to, I certainly wouldn’t do it.

Although the coronavirus panic effect fully exposes the fragility of the stock market (for example, after the twin towers crashed in September 2001, the stock market closed for several days due to panic fears), historical analysis whispers to me to stay true to this preference of mine. It’s also more flexible in terms of territoriality and liquidity, and we’ll know in a year if it will be more profitable in 2020 :).

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