Basically, the sale of real estate by individuals or property administrating partnerships is not subject to taxation if the seller has owned the property for at least ten years. One exception of this principle are activities, to be qualified as commercial trade of real estate. Generally, if an individual or property administrating partnership sells more than three objects in five years, which were not owned by the seller for at least five years, selling will be classified as commercial. As a result, the capital gain from the sale becomes subject to German income and trade tax.

Purchase of real estate for trade purposes
However, under certain circumstances selling of real estate might get classified as commercial even if less than five objects are sold. If there is, from an objective point of view, no doubt that real estate was only purchased in order to realize a capital gain out of a sale the capital gain will also be subject to taxation.

The detrimental intention to realize a capital gain out of the purchase is especially indicated, if the project is only short term financed, if a real estate agent is authorized during the construction phase, if pre-contracts are signed with future purchasers or if a claim to acquire the property is granted. Furthermore, the German Federal Tax Court (Bundesfinanzhof) decided on 7 May 2008 (XR 49/04) that selling real estate soon after the purchase indicates that a long term investment was never intended. With an increasing time period between the purchase of the object and the sale, it becomes easier to justify that the object was initially intended as a long term investment. In a decision of 17 December 2008 (IV R 72/07) the Federal Tax Court has clarified that if an object was owned for at least two years, it cannot principally be assumed that it was only purchased for realizing a capital gain. On 17 December 2008 (IV R 77/06) the Court decided furthermore that capital gains from the sale of property on which a building was constructed by the seller, are taxable if the seller already had the intention to sell the property when signing the construction contract.

Nevertheless, it has to be clearly stated that the aspects listed above are only indicators. In cases in which they accumulate, the risk increases that the capital gain becomes classified as commercial and so will be taxable. However, the burden of proof that an investment was only made in order to realize a capital gain still lies with the fiscal authorities.

Sales of affiliated partnerships are not added
According to a former Fiscal Tax Court decision, real estate sold by a partnership is accounted for when determining the amount of objects sold by a member. However, the court decided on 17 December 2008 (IV R 72/07), that objects sold individually by a partnership member or objects sold by an affiliated partnership have no impact on the (other) members of the partnership. 

Transfer of real estate into a corporation, being controlled by the taxpayer
According to the Fiscal Tax Court decision of 24 June 2009 (XR 36/06), the non-gratuitous transfer of real estate to a GmbH controlled by the taxpayer is an indicator for an investment in order to achieve a capital gain, if the transferred building is still under construction. If the transfer gets qualified as commercial, the gain from the transfer is subject to trade tax.

Usage of a corporation by a private partnership, controlling the corporation
On 22 May 2008 the Fiscal Tax Court of Schleswig-Holstein (1 K 50202/03) decided that, in cases in which a private partnership instructs a GmbH - being controlled by the members of the private partnership - with the construction and the sale of real estate, the capital gain might be taxable. According to the court, cases where both parties agree on a contractual basis that the capital gain accumulates by the private partnership whereas the GmbH will become insolvent, there is given misuse of the law according to § 42 German General Tax Code (Abgabenordnung). As a result, the same principles apply to the private partnership that would apply if it would have realized the project entirely alone. Moreover, the activities of the private partnership could be classified as commercial if it has planed the construction and selling extensively while it was legally obliged to invest into the property by the public authorities.

^{published at Martindale Hubbell}

Contact:
Rupert Klar r.klar @ sibeth.com