What counts as rental income, when it counts, and rent between relatives

Mrs Keller lets her second flat to her son for 400 € a month. An outside tenant would pay 1,000 € for it. Interest, property tax and depreciation add up to 7,200 € a year, and she enters a loss of 2,400 € in her return. The tax office accepts only 40 percent of the costs and, instead of a loss, assesses a surplus of 1,920 €.

The income category and its four groups of cases

Letting and leasing is the sixth of the seven categories of income listed in section 2(1) EStG. It is one of the surplus categories: what is taxed is not a profit drawn from a balance sheet but the excess of receipts over income-related expenses. That is more than a label, because it decides which rules the calculation follows.

The first and most important group in section 21(1) covers immovable property. The provision names land, buildings, parts of buildings, registered ships and rights treated like land, such as a heritable building right. The rented condominium flat, the apartment block and the leased field all fall under it.

Ownership is not required. The provision speaks of letting and leasing, and a person who is only a tenant can let as well. Someone who sublets a room of their rented flat therefore also earns income under number 1, and the corresponding share of their own rent becomes an income-related expense.

The second group covers aggregates of assets, meaning collections of movable items that together serve one purpose. The law gives movable business assets as its example. Whoever leases out the complete equipment of a practice earns income under number 2; whoever lets a flat with its fitted kitchen stays within number 1.

The third group concerns the temporary licensing of rights, such as copyrights or commercial know-how. The fourth covers the sale of claims to rent and lease payments. It applies even when such claims are included in the price of a property and relate to a period in which the seller was still in possession.

Individual movable items are outside section 21. Anyone who rents out their motorhome, a trailer or a cargo bike earns other income under section 22 number 3. That income stays tax-free if it amounts to less than 256 euros in the calendar year. The limit is an exemption threshold: once it is reached, the whole amount is taxable.

Subsection 3 contains the priority rule. Income of the kind described is attributed to another category to the extent that it belongs there. If a rented flat is part of the business assets of a trade, the rent is business income. Section 21 is thus a catch-all rule for private assets, not the rule for every rent.

Finally, sentence 2 of subsection 1 refers to sections 15a and 15b. This mainly concerns stakes in asset-managing limited partnerships and in schemes designed chiefly to generate losses. For the private landlord of a flat, neither provision usually matters; they return in the third module in the context of losses.

Receipts: everything paid for the use of the property

Section 8(1) EStG defines receipts broadly. Receipts are all assets in money or money's worth that accrue within an income category. Subsequent reimbursements of costs are expressly included. The basic rent is therefore only the starting point of what appears as receipts in the return.

The service charges collected for heating, water, refuse collection or property tax are receipts, in the year in which they are paid. Conversely, the amounts the landlord pays to utilities, insurers or the property manager are income-related expenses. In the end the two items largely cancel out, but both belong in the calculation.

A balancing payment from the annual service charge statement is a receipt of the year in which the tenant transfers it. A refund to the tenant reduces the receipts of the year in which it is paid out. A landlord who prepares the 2025 statement in spring 2026 records the result in 2026, not in 2025.

Receipts need not consist of money. If a tenant redecorates the flat at their own expense and is let off rent in return, the value of that work is a receipt. Section 8(2) values such benefits in kind at the usual final price at the place of supply, reduced by customary discounts.

Receipts also include payments that take the place of rent. Examples are compensation for terminating the lease early, payments from a rent-loss insurance or subsidies paid expressly for the letting. What always matters is that the payment economically remunerates the use of the flat.

Not every payment by the tenant is a receipt. A rent deposit remains the tenant's money as long as it is held as security. Only when the landlord offsets it against unpaid rent or damages does something accrue to him to that extent. From that point, the amount offset is a receipt or a reimbursement of expense.

Receipt around the turn of the year and prepayments

For the surplus categories, the cash principle of section 11 EStG applies. A receipt belongs to the calendar year in which the landlord can dispose of it, usually when it is credited to the account. When the rent was due or which month it is meant for does not, in principle, matter.

An exception applies to regularly recurring receipts, and rent is the textbook example. If such a receipt arrives a short time before the start or after the end of the year to which it economically belongs, it is treated as received in that year. December rent arriving on the second of January therefore still counts for the old year.

The law puts no figure on the short time, but the rule covers only payments made immediately around the turn of the year. Rent that a tenant in difficulty pays late in March has not arrived a short time after the year end and belongs to the year of payment.

For larger prepayments the legislator created a special rule. If a tenant or lessee pays in advance for a period of use of more than five years, the landlord may spread that receipt evenly over the prepayment period under section 11(1) sentence 3. It is an option, not an obligation.

For the payer, the same spreading is mandatory under subsection 2 sentence 3. A lessee who pays twenty years of ground rent in advance cannot deduct the outlay in one go. The landlord, by contrast, may tax the money at once if that looks more favourable, for instance because of a low tax rate in the year of payment.

A surplus without a flat-rate allowance

Employees know the employee lump sum, which is deducted without any receipt. There is nothing comparable for letting and leasing. Section 9a EStG grants lump sums only for employment income and for certain other income under section 22; it does not mention rental income.

For the landlord this means that every euro of expenses must be evidenced. Invoices, bank statements, loan agreements and property tax notices are the basis of the return. Anyone who does not keep them risks the tax office estimating the costs, and an estimate rarely comes out in the taxpayer's favour.

Section 9(1) sentence 2 also requires expenses to be deducted in the category in which they arise. If someone lets several properties, a single surplus is still determined for the category. In the return, on the annex known as Anlage V, receipts and costs are therefore shown property by property so that they can be allocated.

What the individual expenses look like, from loan interest to depreciation, is the subject of the second module. For now the equation is enough: the year's receipts minus the year's income-related expenses give the income from letting and leasing, positive or negative.

Letting to relatives: the 50 and 66 percent thresholds

People who let to children, parents or siblings often charge less than they would charge a stranger. Section 21(2) EStG governs what happens for tax purposes. The yardstick is the local market rent for a comparable flat, and the provision applies to every flat let for residential use, not only between relatives.

If the rent is less than 50 percent of the local market rent, the letting is split into a paid and an unpaid part. Expenses are then deductible only in proportion to the paid part. With a rent of 40 percent of the market rent, 40 percent of the costs stay deductible and the rest is private.

If, for a letting intended to last, the rent is at least 66 percent of the local rent, sentence 2 deems the letting to be fully for consideration. All expenses are then deductible in full, although the rent is up to a third below the market. For a family this is the safest arrangement.

Between the two lies a range the law settles only halfway. From 50 percent there is no longer any split, but the presumption of full consideration applies only from 66 percent. Within this corridor the tax office may examine whether a surplus is being sought at all over the long run, and with high costs that test can fail.

Subsection 2 covers only the letting of a flat for residential use. Anyone who lets a shop, an office or a warehouse cheaply to a relative falls outside the percentage thresholds. There, the general question remains whether there is any intention to earn income over the long term.

It matters what the threshold acts on. If the rent is below 50 percent, the receipt itself is not grossed up to market value. The rent actually paid is taxed and only the costs are cut. The loss does not arise because the receipt is artificially increased, but because costs are lost.

A practical consequence follows for rent reviews. Local rents rise over time, while a family rent often stays the same for years. A landlord who was at 70 percent ten years ago may have slipped below 66 percent today. The ratio should therefore be checked regularly and the rent adjusted where needed.

When letting forces a tax return

Many landlords are also employees whose wage tax is in principle final. Letting quickly changes that. Under section 46(2) number 1 EStG an assessment must take place if the positive total of income not subject to wage tax withholding exceeds 410 euros. A rental surplus of 411 euros is already enough.

Conversely, a rental loss does not spare anyone a return; it practically invites one. Negative income is only taken into account if an assessment takes place. Anyone who fails to declare a loss from the start-up phase of a letting gives away the reduction of their wage tax.

Subsection 3 softens the obligation for small amounts. If the income not subject to withholding does not exceed 410 euros in total, the same amount is deducted from taxable income. Someone who is assessed anyway for other reasons thus pays, in the end, no tax on a small rental surplus.