Current issues

If you invest in real estate as a source of additional income, you will typically buy a property, possibly via a company (société civile), take out a mortgage to finance the acquisition and then rent out the property.

You will have to pay registration duties and notary’s fees of approximately 7.5% of the purchase price and cannot deduct them from your rental income. Then every year you will have to pay tax on the net income after deducting expenses, including the cost of maintenance and repair work (and improvements if the property is used as a dwelling) and financial costs.

In the first few years, deducting the “interest” part of your loan payments will make your taxable income roughly equal to your actual income. However, the “interest” part of your loan payments will gradually decrease as the loan is amortised. As a result, your taxable income will increase with no corresponding increase in actual income. If you can keep this up until you’ve paid off your loan, your taxable income will once again equal your real income. But this is not always possible.

Some real estate investors find themselves trapped in a vicious cycle of acquiring new properties to reduce the tax pressure on their rental income, naturally financing the new properties with loans and making improvements to create deductible expenses until their banker refuses to grant any more loans.

To avoid this trap, other investors prefer to form an entity subject to corporate tax. This allows them to write off the acquisition costs and depreciation of the property which, combined with the financial costs, will in practice allow them to avoid paying tax for around fifteen years.

But then they sell their property and discover to their horror that the capital gain they are making will be increased by the amount of the depreciation they deducted then taxed at the corporate tax rate. Had they remained subject to income tax, they would be taxed under the regime for individuals with capital gains from real estate, which provides for deductions based on the number of years the property has been held. The result is a total exemption after 30 years.

You can, however, enjoy the benefits of the corporate tax regime while financing the property and those of the income tax regime when you sell it. To do so, the property must be purchased by a civil (non-commercial) company subject to income tax and the usufruct of that company’s shares must belong to a company subject to corporate tax. This scheme can even be used to refinance a pre-existing property.

Beware, however. A number of precautions must be taken, or the scheme may be challenged by the tax authorities as an abuse of law.

Bornhauser has practised in this area for nearly 20 years and none of the many transactions we have carried out has been reassessed by the tax authorities.