Last week we’ve looked at what the newly proposed 2022 Box 3 (“wealth tax”) does to your FIRE plans. As you likely know we use real estate as part of our FIRE plans. What’s about to change on this front? Here is to Dutch Real Estate and Box 3 in 2022.
Disclaimer: we are not tax professionals and this is only our interpretation of the tax code. Consult a specialist if you want to make sure the tax approach is best your situation!
Why use Real Estate for your FIRE plans in the Netherlands?
With the current Box 3 system (2019), real estate investments get a big tax break. How does this work? Contrary to stocks, bond, crypto-currencies, crowdfunding, etc., where your wealth is taxed based on the actual value at the cut-off date, real estate is not!
For real estate there are several rules as how it defines your wealth (“assets minus debts”) according to Box 3 taxation. Here is my attempt to clarify how it works (values for information purposes):
- Market value of your property (no tenants): €400.000
- Market value of your property in rented state (so with tenants!): €380.000
- Government assessed value (WOZ value) of your property: €360.000
- Tax value in rented state (assuming at least 7% return on WOZ value = 85%): €306.000
- Mortgage (70% value in market rented state): €266.000
Your actual wealth
Based on the above number, your net worth in real life would be €400.000 – €266.000 = €134.000. This is a simple calculation as you just take the value of the property in the open market without any tenants in it. You subtract the value of outstanding debt (your mortgage) and voila.
In case you would have to sell with tenants in it (or you want to be more conservative), you will end up with a net worth of €380.000 – €266.000 = €114.000 for this example. Both numbers assume you don’t have any sales fees.
Your wealth for tax purposes
When determining your wealth for tax purposes with regards to real estate, the government does not look at the market value. They use the government assessed value or WOZ value. This is also the value used for property taxes (OZB). This value is generally lower than the actual market value of the property.
Next, assuming you rent out the property to make money, the WOZ value is corrected using the so called “leegstandswaarde ratio”. This only applies for long term rentals! If your property is making you more than 7% return (yearly rental income over WOZ value), you correct the value of the property to 85% of the WOZ value. In the example above, this give you a property value in rented state of €306.000. If you now subtract the debts (€266.000), you end up with a net wealth for tax purposes of only €40.000!
In this case, your taxable wealth is much lower than in you would have the same wealth in say stocks. For larger wealth numbers, and especially as a couple (where you still get larger exemption amounts / can split the wealth between the two), this really starts to become interesting!
The changes from 2019 to 2022 for Real Estate investing
The 2022 proposed tax change has a particularly big influence on real estate. Firstly the whole “WOZ value in rented state” will be taxed at 5.33%. In this case that means the full €153.000 in the example above. Next you may subtract the debts (€133.000 in the example) at an average interest of 3.03%. Next, you may reduce that amount by either €400 or €800 (single vs couple) as a general income deduction. The remaining value will be taxed at 33%.
For this example:
- €306.000 * 5.33% = €16.310
- €266.000 * 3.03% = -€8.060
- Reduction for a single = -€400
- Taxable income = €7.850
- Net tax (33%) = €2.591
If you would only have income in Box 3 (not in Box 1 or 2), you can also apply the general tax credits (“algemene heffingskorting”) at €2477 (2019 value). Leaving you with €114 in taxes to be paid. As a couple with two times the general tax credits, you would not have to pay any taxes in this example.
Pretty tax graphs
The above example is only for the proposed new 2022 tax system. But would it not be interesting to see the differences between 2019 and 2022? Also for larger real estate portfolio’s with various loan to value ratio’s? I thought you’d never ask 😉
Here are a series of pretty tax graphs (well pretty is not the right word here!). Couple of things to keep in mind:
- Real Estate portfolio sizes are selected at €0.5M, €1M and €2.0M (in rented state), at various loan to value (LTV) ratios (i.e. your actual wealth and net wealth for taxes purposes varies greatly!)
- LTV is based on Market value in rented state. For example, a €2,0M porfolio with 70% LTV means a mortgage of €1,4M.
- WOZ is assumed at 90% of market value in rented state (for calculation purposes only!)
- Taxable wealth according to the “Leegwaarde Ratio” is based on 85% of WOZ value
- Algemene Heffingskorting (“general tax credits”) is based on 2019 numbers: €2.477 per person (also assumed for 2022 examples!)
As a note to this last graph, the taxation amount for singles and couples is nearly identical. This is because of the removal of various different tax brackets as we have now in 2019 for Box 3.
How big does your portfolio need to be to FIRE in the Netherlands using real estate? I’m not able to answer that because it depends on too many variables. It’s based on your personal Return on Investment (ROI), cash-flow, wealth for tax purposes (subject to WOZ and debts), plans for the future, expense levels for you personally, etc.
As to Box 3 wealth tax, your tax burden will likely grow substantially as of 2022, it increases relatively more if you have higher leverage constructions in your portfolio. So you will need more real estate to end up with the same net income to cover your living expenses during FIRE. If you don’t do anything from today, your cash-flow on a yearly basis will obviously get a hit.
What we don’t know for sure is if the “leegwaarde ratio” will remain, or might be updated with the 2022 tax update. What will likely happen in the future is that the WOZ value will increase too, this will be another indirect additional tax burden that may even outpace inflation and rent indexation.
That being said, I’ve also looked at the difference between FIRE portfolio with real estate and one with stocks/bonds. This has some interesting conclusions!
Where last week we noted an impact of nearly €200.000 in our wealth target to be FIRE in 2022. That’s a lot of money and would required us both to go back to work for the coming years to make FIRE happen in 2022.
But, due to the effect of real estate in our FIRE portfolio, the additional wealth that we would need is limited to “just” about €100.000 (or one extra rental unit). This also has to do with cash-flow and moving to another property in the coming years. So not all is lost 🙂