Production Costs Closely Related to Acquisition: The 15-Percent Threshold

What are production costs related to acquisition?

Renovation costs that the law retroactively counts toward the building’s value are considered costs incurred shortly after acquisition. This rule is set forth in Section 6(1)(1a) of the Income Tax Act (EStG): If repair and modernization costs within three years of the building’s acquisition exceed 15% of the building’s acquisition cost, excluding VAT, they are included in the construction costs. The building’s acquisition cost also includes its share of notary, land registry, and real estate transfer tax costs.

The difference is noticeable. A landlord generally deducts maintenance expenses in the year they are paid. Construction costs increase the value of the building and are accounted for only through annual depreciation. For rental income, the rule set forth in § 9(5), sentence 2, of the Income Tax Act (EStG) applies accordingly.

What counts toward the 15 percent?

All repair and modernization costs for the building incurred within the three-year period are added together. The Federal Fiscal Court made this clear in 2016: Cosmetic repairs such as wallpapering and painting are included, as are measures that make the building rentable in the first place, and the replacement of windows, bathrooms, or room layouts (BFH, ruling of June 14, 2016, IX R 22/15). The tax authorities go even further: Cosmetic repairs are always included, even when performed on their own and without any connection to a larger repair or modernization project.

Hidden defects are also included. It doesn’t matter whether you could have foreseen the costs. If you repair damage that was hidden at the time of purchase but already existed, you’re responsible for 15% of the costs. The only exceptions are damages that arose after the purchase (see “What doesn’t count?”).

If a third party, such as an insurance company, reimburses part of the costs, or if a grant is available, only the remaining amount after reimbursement counts.

The costs aren't broken down into separate categories. There isn't a separate bill for the wallpaper and another for the bathroom. One asset, one time period, one total.

The criterion is the economic asset. A multi-family residence that is rented out in its entirety constitutes a single economic asset; in such cases, the tax office applies the threshold to the entire building. If a building is used for different purposes—for example, partly rented out, partly owner-occupied, and partly used for commercial purposes—it consists of multiple economic assets. In that case, the limit is assessed separately for each part, with a correspondingly lower limit.

What doesn't count?

The law expressly excludes two categories: expenses for expansions as defined in § 255(2), first sentence, of the German Commercial Code (HGB), and maintenance work that typically occurs annually. Expansions are considered production costs in any case, so the 15% threshold does not apply to them.

With regard to annual maintenance work, the Federal Fiscal Court cites an example from its ruling: regular heating system maintenance. In the case in question, such costs remained immediately deductible, even within the three-year period.

A built-in kitchen is considered a single asset and is depreciated over ten years (Federal Fiscal Court [BFH], ruling of August 3, 2016, IX R 14/15). The sink, stove, built-in cabinets, appliances, and countertop together constitute this single asset. The complete replacement of a built-in kitchen is not deductible as a maintenance expense, and it is not included in the 15% total.

This also does not include compensation paid to tenants for early vacating of the premises or damage to the property that occurred after the acquisition—whether by chance, such as through a natural disaster, or through the fault of a third party.

How long does the three-year period last?

The period is calculated to the exact day, starting from the transfer of ownership, risk, benefits, and encumbrances. It therefore begins with the handover—not with the notarization of the purchase agreement, nor at the beginning of the year—and ends three years later. The key factor is when the work is performed. Renovation work carried out in the fourth year is no longer included in the total.

At the end of the three-year period, the work does not have to be completed, settled, or paid for. If a construction project extends beyond the end of the three-year period, only the construction work performed up to that point is taken into account; if necessary, the portion of the work is estimated.

If you inherit a building or acquire it otherwise without payment, you take over your predecessor’s three-year period. If the decedent purchased the house two years ago, you have only one year remaining.

In its ruling, the Federal Fiscal Court also considers renovations carried out between two tenancies to be part of the review. A break in the tenancy does not suspend the deadline.

Deduct Immediately or Write Off: Two Model Calculations

What about major maintenance costs that fall below the threshold?

Under Section 82b of the Income Tax Implementation Regulations (EStDV), major maintenance expenses for a building may be spread evenly over two to five years rather than being deducted in the year of payment. The requirements are as follows: The building is not part of the business assets and is used primarily for residential purposes—that is, the living quarters account for more than half of the usable floor space.

If the building is sold before the end of the allocation period, the remaining portion not yet taken into account is recognized as income-related expenses in the year of sale. The same applies if it is transferred to business assets or is no longer used to generate income. So nothing is lost. If the building is owned by multiple people, they all allocate their share over the same period.