Ruling by the Federal Finance Court on Tax Exemption Due to Personal Use, Ref: IX R 14/22
If the purchase and sale of a property occur within less than ten years, the capital gain is subject to taxation. An exception is made for personal use. In this case, tax exemption is possible if the sale occurs within the ten-year speculative period. However, the sale of a separated garden plot before the end of the speculative period is not tax-exempt, as decided by the Federal Finance Court in its judgment dated September 26, 2023 (Ref: IX R 14/22).
When a property is purchased and resold within ten years, this constitutes a so-called private disposal transaction. The profit from such a transaction is generally taxable and subject to income tax. An exemption from taxation is only possible if the property is personally used by the taxpayer, according to the commercial law firm MTR Legal Attorneys, which provides counsel in tax law among other areas.
No Tax Exemption for Separated Garden Plots
However, such an exemption does not apply if a garden plot is separated and sold, as clarified by the Federal Finance Court (BFH) in its decision of September 26, 2023.
In the underlying case, the taxpayers had purchased a property with an old farmhouse in 2014. They lived in the building and had a roughly 4,000 square meter plot, which they used as a garden. Later, they separated and sold a strip of about 1,000 square meters from this garden in 2019.
The taxpayers made no declaration regarding the sale of the part of the land in their income tax return. However, the responsible tax office captured the sales proceeds in the income tax assessment of 2021 and taxed it according to the Income Tax Act.
BFH Dismisses Lawsuit
The taxpayers contested this decision. They argued that the sale of the part of the land did not constitute a private disposal transaction, or at least that the capital gain, due to being used for their own residential purposes, should not be taxed.
However, their lawsuit was ultimately unsuccessful at the Federal Finance Court. The judges in Munich decided that the sale of the land generated other income from a private disposal transaction that should be taxed.
If less than ten years have passed between the acquisition and disposal of a property, other income from a private disposal transaction is generated. According to § 23 of the Income Tax Act (EStG), value changes realized within the ten-year disposal period of a particular economic good in private assets should be subject to income tax. Economic partial identity is sufficient, stated the BFH.
Other Income from Private Disposal Transaction
Economic partial identity is considered when an economic good is acquired but only partially resold. The economic identity of a divided economic good remains partially intact if the division can be carried out without extensive technical measures and the marketability of the previous economic good continues in parts. This is the case, for example, with the subdivision of land plots, the BFH explained.
Therefore, the tax office and the Lower Saxony Finance Court correctly assumed other income from a private disposal transaction in the present case. Although the land plots differed in size after the sale, they otherwise did not differ in their nature, function, and value from each other, according to the BFH.
Use for Residential Purposes Only in Case of Developed Land
The capital gain could not be exempted from taxation due to personal use for residential purposes, further clarified the judges in Munich. Exemptions from taxation were only possible if the property was used exclusively for personal residential purposes between acquisition and disposal or in the year of disposal and the two preceding years. This requires that the economic good be permanently inhabited by the taxpayer himself. This is not the case with undeveloped land. Therefore, only the land with the residential building could be exempt from taxation, not the undeveloped part of the land. This also applies if a previously used garden plot is separated and sold, decided the BFH.
MTR Legal Attorneys provide counsel in tax disputes with financial authorities and other tax law matters.
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