Lease Agreement with a Spouse

BUSINESS EXPENSE DEDUCTION REJECTED BY THE TAX AUTHORITIES

The lease payments for a hotel to the owner-spouses were made so irregularly that the tax office did not recognize the contract and rejected the business expense deduction entirely. The Cologne Fiscal Court, to which the matter was appealed, upheld the tax office’s decision.

BACKGROUND INFORMATION

The wife operated a hotel owned by her husband. The lease payments were made in the form of varying monthly amounts that were paid or transferred. Nevertheless, over a period of seven years, a total of 34 percent of the agreed-upon rent was not paid at all. The tax judges denied tax recognition to the entire lease agreement. According to the grounds for the judgment, a contract concluded with a close relative can only be recognized if it was legally valid and if the terms agreed upon and the manner of performance meet the arm’s-length standard. However, deviations from customary terms and deficiencies in performance must be of some significance.

Contract Valid, Execution Not

A significant deficiency exists when substantial portions of the lease are not paid at all or are paid only in a subsequent year. The practice of making payments based on the tenant’s cash flow situation was the reason the judges refused to recognize the entire lease agreement.