Letting an apartment to family members: How to ensure tax compliance?

Renting an apartment to family members appears to be the simplest solution – fewer formalities, more trust, no problems. However, it is precisely these arrangements that are considered particularly subject to scrutiny by the German tax authorities. The taxation of rentals to relatives is governed by its own set of rules; even small “family favors” can cast doubt over the validity of the entire agreement. To avoid errors and ensure proper taxation of income, it is crucial to understand the transition from the private to the tax-relevant sphere. 

Taxation of Rentals to Relatives – How to Avoid Pitfalls and Settle Income Correctly?

At first glance, renting to relatives may seem uncomplicated – after all, it involves “one’s own”, so formalities are often neglected. However, this is where the first problem arises. For the German tax authorities, it is irrelevant whether the tenancy exists with a son, sister, or parents – what matters is whether the agreement, in its content and execution, corresponds to one concluded between unrelated third parties. If this requirement is not met, the rental contract may quickly be classified as pertaining to the non-taxable private sphere, with corresponding tax consequences.

It is therefore advisable to pause before signing the contract and ask the following question: Would this property be rented on the same terms to a completely unrelated person? If the answer is “probably not”, caution is warranted. For tax recognition, the rental to relatives requires a genuine economic relationship – with a clearly agreed rent, fixed payment dates, and actual bank transfers. The tax authorities are uninterested in declarations of intent – what counts are actual account transactions and documentation.

In practice, this means that every contractual detail must be considered and coherent – from the amount of rent to the settlement of operating costs and the regularity of payments. Even minor and accumulating deviations can result in the tax office viewing the relationship as private and not as income-generating. In such cases, tax planning would become obsolete.

Renting to Family Members – When Does the Tax Office Recognize the Contract and When Is It Considered a Sham Contract? 

Whether the tax office recognizes a contract essentially depends on a central mechanism – the so-called arm’s length principle. It is not about exact numeric equality, but rather the overall picture of the contractual relationship. If there is a community of interest between landlord and tenant instead of a genuine business relationship, the tax authorities will examine all circumstances particularly carefully.

Problems frequently arise where the rent is only paid symbolically, irregularly, or not at all, even though the paperwork appears in order. From the perspective of the tax administration, this is not considered a rental but a form of financial assistance. In such cases, taxation of income from rentals to relatives is no longer possible, as there is no tax-relevant income event.

It must also be noted that the mere existence of a contract is not sufficient. What matters is contract performance – i.e., whether rent is actually paid, whether payments are enforced, and whether the relationship is economic and not of a family nature. Any situation where money “flows back to the tenant” or payments are mere formalities arouses suspicion. Such details ultimately determine whether the contract is recognized or rejected in its entirety.

Rent for Family Members and the 66% Threshold – When Is Full Deduction of Expenses Possible?

When renting to family members, the level of rent in comparison to the local market rate is of central importance. Under German tax law, reference is made to the so-called local customary rent, meaning the gross rent customary for comparable apartments in a similar location – including apportionable service charges. If the agreed and actually paid rent is set at at least 66% of this local customary rent, the tenancy is considered remunerated and the landlord can deduct all income-related expenses such as interest, renovations, depreciation, or administrative costs in full.

Example: If the local gross rent for a comparable apartment is €1,000 per month, the safe threshold for full cost deduction is €660. If rented to family members for €700, i.e., 70% of the market rate, full deduction of all costs related to the rental is usually possible. For annual expenses of €6,000, these can then be claimed in full as income-related expenses. If the rent is €600, i.e., 60% of the market rate, the tax office may require a forecast of total surplus – a projection for the overall return of the tenancy. If the projection is positive, full cost deduction remains possible; if negative, the costs are only partially recognized.

The greatest risk arises when the rent falls below 50% of the local customary rent. In such cases, the tax office splits the rental into a remunerated and a gratuitous part; income-related expenses may then only be claimed proportionally. If the local customary rent is €1,000 and the family rent is €400 (= 40% of the market rate), only €2,400 out of €6,000 annual costs are tax-deductible. Therefore, it is advisable when renting to family members to set the rent at least at 66% of the local reference value and to ensure regular, actual payments.

”

Anyone renting an apartment to family members should collect a small “evidence file” once a year: obtain the current rent index, gather several rental offers from the neighborhood, and record the rent calculation. This requires only a few minutes but proves invaluable should the tax office question the rent level after some years. Especially for rentals to relatives, complete documentation is as important as the rental contract itself.

Renting to Family Members and Taxes – What Must Be in Order for the Contract to Be Recognized for Tax Purposes?

To ensure tax certainty, utmost care is required. The taxation of lease relationships between relatives is subject to various requirements, which together must present a coherent overall picture: The tenancy must appear market-standard. The contract should be clear, complete, and preferably executed in writing, even if not legally required.

Particularly important are aspects that are often taken for granted, but frequently missing in practice: precise determination of the rent amount, payment due dates, settlement modalities for operating costs, and provisions on the use of the apartment. Missing details may be interpreted as evidence of lack of contractual intent. These are not mere details, but fundamental prerequisites for the tax classification by the tax authorities.

Equally crucial is the actual implementation of the contract following its signing. Regular transfers, no arrears in payments, and the effective execution of the contractual terms are indispensable for the tax administration. If rent payments are late or not made at all, even the best contract loses its tax relevance. Actual actions are decisive, not declarations of intent.

Taxation of Rentals to Relatives in Practice – How To Conduct “Intra-family” Rentals in Compliance with the Rules?

Theoretically everything is clear, but in practice many fall into the same patterns. When renting to related parties, formal requirements are often not strictly observed, payment obligations are handled generously, and the rent is seen more as a “symbolic gesture” than as a serious obligation. This is precisely where the biggest issues arise.

For a proper taxation of rental income from leases with family members, strict separation of the private and financial spheres is essential. Family ties must not influence the terms of the tenancy for tax purposes – at least not in a way that is discernible to the tax authorities. This means that even with fundamental trust in the tenant, the treatment must be as with any other contractual partner – including consistent enforcement of contractual agreements.

In practice, this also means that payment arrears over several months, later “compensatory payments” or adjusting the rent to the tenant’s personal situation are not permissible. Such practices may be common within the family but are entirely at odds with tax requirements. It is this perspective of the tax office that is decisive for recognition for tax purposes.

Taxation of Rental Income from Leases to Relatives – How to Avoid Difficulties?

For greater legal certainty, the circumstances should be assessed objectively and pragmatically. The most important point is that the contract and its actual execution do not give rise to any doubts. Essential prerequisites include: market-appropriate rent, regular payments, no hidden financial interconnections, and clear rental terms.

Another frequently overlooked point is the overall coherence of the contractual relationship. Even if a single error does not lead to the complete loss of tax privileges, several minor deviations can negatively affect the overall picture. The greater the deviation from market norms in individual aspects, the more likely it is that the relationship will be classified for tax purposes as private rather than income-generating.

Ultimately, perfection is not required; credibility is decisive. If a coherent economic concept exists alongside consistent contract performance, correct accounting is likely. If, however, the contract is regarded only as a formal act, difficulties are inevitable sooner or later—and in such cases, correction is usually hardly possible.