Rental Agreements with Family Members: What Tax Considerations Should You Be Aware Of?

If you own a property, you may want to rent it out to relatives or your children. In such cases, the rent charged to family members is often significantly reduced. As a landlord of an apartment, you can claim expenses related to the rental property for tax purposes. If the apartment is rented to a relative at a lower rate, there are several factors to consider. Rental agreements with relatives are often scrutinized critically and, above all, very closely by the tax office. Unfortunately, we repeatedly see rental agreements being rejected due to avoidable mistakes. As your tax advisor in Düsseldorf and tax advisor in Oberhausen, we therefore want to make you aware of some important aspects in this article.

Why can a rental agreement with close relatives be problematic?

Generally speaking, it is possible to rent a property to relatives under “unnaturally” favorable terms without any issues. Landlords need not expect any legal obstacles in this regard. From a tax perspective, however, disadvantages may arise that should be avoided.

As a property landlord, you incur various costs, such as for repairs. These expenses can be claimed for tax purposes. For the costs to be recognized by the tax office, a valid lease agreement must be in place. Rental agreements that would not “normally” be concluded with a third-party tenant are subject to tax scrutiny. For example, if you rent your apartment to a relative for half the market rate, this could be challenged by the tax office.

It is therefore very important that you observe certain principles when renting to relatives. Please note that in this article we can only provide a general overview, and each individual case is reviewed by the tax office.

Who are close relatives?

In the context of rental agreements, the tax office refers to so-called close relatives. As mentioned earlier, anyone entering into a rental agreement with “close relatives” must exercise caution. Close relatives include:

• Fiancés,
• spouses, registered partners,
• parents and grandparents,
• children and grandchildren,
• siblings,
• brothers-in-law/sisters-in-law and nieces/nephews,
• foster parents and foster children.

In addition to these obvious relatives, there are also special cases. For example, in the case of divorced individuals or unmarried couples living together, a lease agreement may not be recognized for tax purposes.

What are the requirements for rental agreements with relatives and children?

First, a lease agreement with relatives must also meet formal requirements. The standard components of contracts must be observed. Only legally permissible agreements may be made. The lease agreement should always be in writing for evidentiary purposes. It is very important that lease agreements must not be “backdated”! If you, as a landlord, think you can save on taxes this way, you run the risk of being surprised by legal proceedings for tax evasion.

In principle, freedom of contract applies, allowing you to freely determine the terms of the lease agreement. However, under tax law, the so-called arm’s-length principle must be observed. Accordingly, the lease agreement must be “normal” and structured as it would be with a “third party” in order for it to be recognized by the tax office. Thus, while it is possible for your children to contractually pay only one euro in rent, this would not be a valid arrangement under the arm’s length principle for tax purposes.

If the tax office classifies the lease agreement as “abnormal,” it may be that a deduction for income-related expenses is only partially possible or not possible at all.

It is also important to note that it is not sufficient for the lease agreement to have been properly executed. The agreed terms must be “put into practice.” This means that the relatives must actually move in and pay the respective rent. If the lease agreement is concluded merely “for appearance’s sake,” you risk facing legal proceedings for tax evasion.

Do you need a tax advisor for rental agreements with family members?

Many landlords forego the professional assistance of a tax advisor. Unfortunately, this increasingly leads to mistakes and tax disadvantages. There are a multitude of specific regulations that we cannot cover in this article. Therefore, we are convinced that it is worth consulting a good tax advisor for every rental agreement with family members.

As tax advisors in Düsseldorf and Oberhausen, we can help you draft a sound lease agreement with your relatives. Our team is familiar with the “pitfalls” and will ensure that you receive the best possible tax benefits. We look forward to meeting you in Düsseldorf or Oberhausen. Please feel free to contact us.