How we ignored the tax variable in our investment calculations and screwed up for the next 19 years

Income tax regulations vary depending on:

• whether you are a professional leaser or a nonprofessional leaser

Basically, you are considered a professional leaser if your annual rental income reaches a certain amount of money (around 20,000€ I think) and/or if you are a registered company. Otherwise, you are considered a nonprofessional leaser. Fred and I fall into the latter, of course.

• and whether you rent out furnished places or unfurnished places

When you rent out unfurnished properties, your rental income is taxed in a category called “real estate income”, whereas when you rent furnished properties the category is called “industrial and commercial profits”. So, Fred and I are taxed as nonprofessional leasers in the “industrial and commercial profits” category.

There are two ways of declaring taxes in that category:

• micro-BIC

If your annual rental income is less than around 75,000€, you can qualify for what they call “micro-BIC”, which simply means “micro industrial and commercial profits”. The advantage is that the paperwork is light: you are taxed on 29% of your rental income (income, not profit). The tax percentage depends on the tax bracket you belong to. The reason why you are taxed on 29% of the rental income is that they consider that 71% cover for legitimate rental -related expenses (such as community expenses, owners’ tax, renovation of property, etc.).

This is a great plan if your expenses amount to 71% or less of your rental income. But if your expenses amount to more than 71% or if you are in deficit, it’s another story. So, if you don’t qualify for the micro-BIC plan or you feel it’s not the best option for you, you can use the second method, called “simplified actual profits plan”.

• simplified actual profits

The simplified actual profit plan enables you to declare your exact income and expenses and therefore pay taxes only on the money you did profited. If you are negative, your loss is transferred to the next year’s tax return and taken into account in the calculation of the tax category your fall into (either real estate or industrial and commercial profits).

The downside is that it entails heavy legal and bookkeeping obligations. If you have a good accounting background, maybe you can handle it. If you are like us though, you’ll have to hire the services of an accountant: the estimate we requested amounted to 600€ annually.

So Fred and I started doing the math. Since we are in deficit this year and the deficit can be transferred to next year’s tax return, the decision is to be made by comparing the accountant’s fee to the amount we would have to pay in taxes in the micro-BIC plan (20% of 29% of our rental income) and the amount of the loss that we can transfer.

And here comes an important variable that we didn’t know: because we invested in our own names, our loan payments are not considered expenses in our tax return. This means that, in the eyes of the law, we are almost breaking even while really we are in deficit. Therefore, the amount in taxes that an actual profit plan would save us is less than the accountant’s fee: it’s simply not worth the extra expense and hassle.

After realizing that our loan payments were not considered legitimate expenses, Fred and I started digging and we found out that loan payments are deductible only for companies, not private persons. At that point, we thought we could just create a company (in France, there is a special type called SCI –real estate civil company— that could meet our needs although they require extra legal obligations every year), sell our flats to our own company for an insignificant price, pay the relevant taxes for change of ownership and next year be able to deduct the loan payments.

That sounded like a possible plan but you know what: we got our loans in our own names and only if they are in the name of the company can they be deducted…Basically, we totally screwed up (again!) and are now bound to paying taxes on profits we don’t make.