With the proposed new tax laws for 2022, there are a lot of changes for real estate investing in the Netherlands. The primary conclusion is that owning real estate as of 2022 will be a lot more expensive, tax wise anyways. This begs the question, what is the best place (from a tax perspective) to allocate your real estate portfolio. We did a post a while back (2017) about this, which favoured Box 3. However, if we now incorporate the proposed chances for 2022? Today’s post is all about Dutch Real Estate: Box 1, 2 or 3?
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!
Real Estate Taxation Options Introduction
The Dutch tax system gives you various options to manage the taxation of your Real Estate. It all depends on what you want to achieve and how actively you want to participate in your Real Estate. In this post we will look at 3 taxation options:
- Taxation of Real Estate income in Box 1:
- Taxation on Real Estate when incorporated, with Box 2; and,
- Taxation of return on your wealth in Real Estate in Box 3.
Let’s have a more detailed look at that the different options would entail. Note that the general deduction (Algemene Heffingskortingen) should be the same for 2 and 3 options. However, it is subject to your income for Box 1 and therefore varies!
Box 1 Real Estate Income Option
First off, in principle the government almost always sees your real estate as wealth under Box 3. However, and this is where the tax law gets a bit fuzzy too! When your Real Estate ventures (buying, sell, renting out) start to resemble “an active business”, the income is taxed as if you “work”. In this case your real estate income would be considered under Box 1. For the Dutch among you, this is a good post with some clarifications from past court cases.
For this assessment we assume you actively manage your own properties (assumed as long-term rentals) and that taxation is based on 100% of your net profits (income minus expenses). It is also assumed that both the general tax deduction (“algemene heffingskorting”) and “labour” deduction (“Arbeidskorting”) apply and are pro-rated on the actual net income as applicable.
One note, if you just AirBnB out your own house, you only have to add 70% of your income to Box 1! Also, if you rent out a room in your house and don’t get more than €5.367 (after interest deduction) a year in rental income, you don’t have to declare the income in Box 1.
Box 2 Real Estate Dividend Option
Another option to deal with your Real Estate is to incorporate into a business. In this case you can manage the properties anyway you please. You can also use the depreciation of the buildings and pretty much all other costs to limit your profit (and thus taxes).
However, for sake of this exercise we only look at minimal expenses to have “sufficient” income to live during your FIRE years. During your buildup phase, you could have a different approach as to how you use Box 2!
On the company profit you will have to pay 15% tax (flat rate 2021 up to €200.000 profit – “Vennootschapsbelasting”). Whatever is left, you can pay to yourself as dividend, which is taxed at another 26.9% (flat rate 2021). In short, your net profits are effectively taxed at 37.87% (2021 only!).
Couple things to consider. There is a “ter beschikking stellen” clause in the dutch tax code. This means that if you loan money to your own business, you have to report income on this loan under income taxes (Box 1). If you already have paid employment, this taxation could be as high as 49.50% (2021 rate)! Also, the interest rate you have to ask your own company is commonly around the 6% mark (as it’s an commercial unsecured loan).
Probably the best way to add investment capital is to create a BV (corporation) and add (share) capital (e.g. “aandelen kapitaal” and/or “eigen vermogen”) to the reserves of the company. That way it’s able to be invested, but not taxed (it’s not profit in Box 2, nor wealth under Box 3).
Box 3 Real Estate Wealth Option
The proposed 2022 Box 3 taxation is based on your wealth and an assumed return on investment on this wealth. For real estate purposes this wealth is calculated as the government assess property value (WOZ) times a factor (“leegwaarde ratio”) that is based on the rental income. If you have a profitable property, this percentage is usually 85%. This wealth is assumed to have returned at 5.33% (2019 rate)
You may now reduce this income amount by your mortgages at a set percentage (3.03% for 2019). Next there is a general income tax credit (€400 for a single – €800 for a couple). Whatever income is left will be taxed at 33%. More details on the calculations and some examples can be seen here.
Let’s compare the 3 taxation options to see which one is best to FIRE purely on real estate alone in the Netherlands.
We have assumed the following for a single person:
- Property market value (4 units) €500.000
- Properties WOZ value (4 units) €450.000
- Yearly rental income (8% gross) €40.000
- Insurances: €1.600
- Maintenance (2.5% market value): €12.500 (assumed primarily done by external parties; equal amount spend/reserved each year)
- Property Taxes, sewage, garbage, etc.: €2.500
- Marketing Costs (€20/month): €240
- Property Management (tenant selection): €1.600
- Property Management (total summation of monthly fees): €2.500
- Yearly business expenses (year end statement, accountant, etc.): €1.000
- Box 1 taxes as per 2021 (income tax 37.05% up to €68.507 income)
- Box 2 taxes as per 2021(Profit tax of 15% and “dividend tax” of 26.9%)
- Box 3 taxes as per 2022 (assumed return and debt rates as per 2019)
- Income tax deduction Box 3: €400
- General Tax Credit (as per 2021): €2.753 (prorated as per 2019 distribution for box 1)
- You have not yet reached the formal retirement age (“AOW leeftijd”).
Utilities are assumed to be paid by the tenants. We have kept costs for insurances, property taxes and maintenance the same for all options. Since no tax rates are available for 2022, we have assumed the 2021 rates and the 2022 tax system for Box 3 for the calculations. Not perfect indeed, but it should give a reasonable comparison between the various taxation options as of 2022.
Comparison Box 1, 2 and 3 – No Mortgage Case Study
Next are the 3 taxation options for a single person with a net worth of €500.000 in paid off real estate.
Box 1 Tax Results
Based on the assumptions above, the Net Income is about €21.130. You could still improve this number by doing (some of) your own maintenance. But note that for every Euro you reduce expenses, you only get about €0.6 back in net income (due to taxation effects)
But what if you are lazy and only want to paint your windows every now and then? You don’t want to deal with tenants and the paper work? That’s fine, you can probably still have it taxed as Box 1 as long as you do some of the (e.g. maintenance) work yourself. In that case you get this:
This means that if you have about 4-5 apartments which are managed for you, you can have about €1.550 a month without much effort in Box 1. Not too bad!
Box 2 Tax Results
The total net income comes to just €16.441 in Box 2 if you do the work yourself. That’s a whole lot less than Box 1. This is due to the large tax credit you receive if you “work” in this country.
There is one big note as you perform (part-time) work at/for the company as you actively manage the properties. If you work (part-time) for the company you also need to pay yourself income (which comes in Box 1 for tax purposes).
However, for simplicity reasons, this has not been taken into consideration here. If you would, the profit, and thus the available dividend, becomes smaller. You would get some of this lost income back via Box 1 income and due to tax credit probably end up with more money!
Same as with the Box 1, what if you have all works subcontracted and you only run the company (with very little time involved)? You get this:
Box 3 Tax Results
The net income here is just €15.457. That’s the lowest net income of the three, even if you more fairly compare with the managed options in Box 1 or 2 (albeit the difference between box 2 and 3 is minimal). What a change from 2017!
Comparison Box 1, 2 and 3 – With Mortgage Case Study
What happens if you do have a mortgage, but the same net worth as the previous example? What if you have a larger portfolio, but with mortgage. Here is another comparison for ya!
Here are the updated assumptions for a single person with a bigger leveraged portfolio (but same net worth of €500.000):
- Property market value (8 units): €1.000.000
- Properties WOZ value (8 units): €900.000
- Yearly rental income (8% gross): €80.000
- Mortgages (at average interest rate of 2.5%): €500.000
- Mortgage expenses: €12.500
- Insurances: €3.200
- Maintenance (2.5% market value): €25.000 (assumed primarily done by external parties; equal amount spend/reserved each year)
- Property Taxes, sewage, garbage, etc.: €5.000
- Marketing Costs (€40/month): €480
- Property Management (tenant selection): €3.200
- Property Management (total summation of monthly fees): €5.000
- Yearly business expenses (year end statement, accountant, etc.): €1.000
Box 1 Tax Results
Here are the two options for doing most of the work yourself, and the hammock version with you rarely lifting a finger. But both taxed in Box 1 for income tax purposes.
As can see, leveraging also works for Box 1 income. Having the same net worth on paper, the leveraged option provides you with €27.292, rather than €21.130 in net income without leverage.
Even the hammock version of this approach works in your favour, with €22.830 net income vs €18.843.
However, there is a big note here, this is not net-cashflow! Since you have €500.000 in debts, and assuming you have an annuity mortgage, you have to pay this off. The monthly payment here is ~€2.243 (or ~€26.916 on a yearly basis). In this case your net cash-flow will be around €14.416 lower for both options! That means you probably won’t have sufficient income to live off. Bummer.
Box 2 Tax Results
Same as with box 1, you see the benefits of leveraging your real estate in Box 2. The added benefit is that your business expenses probably won’t change from the non-leveraged version. Here are the calculations:
Again here, lots of extra income with the leveraging, but cash-flow wise a problem. Especially here as you technically cannot pay out the net income due to cash-flow restrictions (you might be able to get the money from the reserves of the company, if there are any).
Box 3 Tax Results
And here is the final one from Box 3 with leveraging:
In the compared to the non-leveraged version with €500.000 net worth, you are up over €5.000 in income (from €15.457 to €20.529). That is actually more than the hammock version in Box 1 (which increased by only about €4.000). That being said, same cash-flow issues exist here too.
Comparison Box 1, 2 and 3 – €1M Portfolio – No mortgage
Last comparison for today. Let’s assume you have (already) paid of your mortgage as mentioned in the previous comparison. You thus have a portfolio of €1.000.000 without any debts. This means a higher income and less tax credits for the Box 1 option, the Box 2 option just has lower expenses and Box 3 no longer has debt deductions. The cash-flow now obviously should work in all scenario’s.
Let’s assume you are getting older (but are not yet formally retired!) and don’t want to “work” your real estate much yourself anymore. What is then you best option? Here are the three “hammock” options:
The net incomes are creeping closer together as you can see. The box 3 option is now slowly getting more interesting once again compared to Box 1 and 2. This is due to the reduction in tax credits for Box 1, which decrease with increasing income. However, Box 1 in this example is still more interesting, with the note that you really should not have any other income (pension, job, side hustle or anything) to make this work.
There are obviously lot’s of assumptions and simplifications in these calculations. It’s imperative that you calculate through your own situation to find out what works for you. Also age has an impact due to changes in tax brackets once you reach formal retirement age (AOW leeftijd). But that is also the time you will start to receive income again (hopefully) from AOW, pension and/or insurance products (lijfrentes). This will start to affect the height of you Box 1 income and thus whether putting your real estate income here is a smart idea. It still might, but you would have to calculate that for yourself.
It really depends on what phase you are in during your FIRE journey, as to what Box might be interesting. If you have a job and a decent income, you really don’t want you real estate income in Box 1. That would likely be brutal in taxation terms (and on daycare benefits for example!).
However, once you stop working, it might very well be a smart idea to shift your real estate income to Box 1, just to benefit from the various tax credit available. But there is a limit here. For example if you have a big portfolio (>€1M) with ditto income, there will be a crossover point where you are better off keeping it in Box 2 or 3. Even with the proposed new tax rules.
Single vs Couple
All the shown examples are done based on being a single. If you are a couple, you get more tax credits in all scenarios. However, Box 3 get’s hit even harder from 2017 to 2022. That being said, moving your real estate into Box 3 might be most interesting as you get both credits twice! So the current perks in Box 3 kind of get shifted to Box 1.
After seeing these calculations, we are now strongly considering both getting new jobs and work hard in the next two years. Killing most of our debts in the process to increase cash-flow. Then both stop working in 2022, move to a different house and switching all our real estate into Box 1. It really seems the smartest thing to do. The good thing here is that we can use the benefits of Box 3 for the coming years (where taxation is currently still really low), and switch when they disappear.
There are a few other perks in Box 1 and 2, that you don’t get in Box 3. You can deduct expenses related to your real estate. In short, if you do your own tenant selection, screening and maintenance you need stuff. You need a phone, and a computer, and an internet connection. You also need tools. Heck you perhaps even need a car! See where I’m going with this? There are obviously rules as to what you are and are not allowed to deduct, but there is some room to play here.
There is a big perk for Box 2, which you don’t have in either Box 1 or 3. Limited liability. When you incorporate you protect you personal wealth from lawsuits (assuming you did nothing wrong or against the law). Especially if you have a larger wealth, this could start to become important and worth the lower net income. Risk management is key.
As noted before, the Dutch tax system can be complicated and has many exceptions and exclusions. It also changes as you can see, especially the major difference in how Box 3 is being taxed. Changes can have a major impact on your FIRE journey and when you don’t have a job anymore. Or, whether you perhaps want to keep a job during FIRE. It strongly affects how you setup your wealth and how want to have it taxed. That being said, due to the changes, it seems that Box 1 might actually become pretty interesting as of 2022, even if you don’t want to do a lot of the work yourself!
Thoughts, ideas, errors? Bring it on!