We have previously covered the basics with regards to Dutch taxes, which you can find here. Real estate investing is, however, going to complicate things a bit further, but also provides some opportunities to lower you tax burden if you understand the (current) rules.
The following is critical to realize (considering the same property and about the same cash flow).
Actively Investing in Real Estate
If you actively manage your own investment portfolio (e.g. DIY maintenance, cash collection, tenant screening and selection, etc.) the income from your real estate is considered income in Box 1. You will be taxed on 70% of the net profits (i.e. income minus expenses). Considering the lowest tax bracket within Box 1 is 36% at this time, you will effectively be paying a minimum of about 25% taxes (70% * 36%) on your net profits. If you earn a decent income, and you are in the 52% tax bracket, you pay even more at about 36% (70% * 52%). Ouch….
If you plan to rent our a room or your whole house/apartment via AirBnB (or equivalent), you are considered by the governmant as “actively working” to get income. In short, you have to file income you make from AirBnB as income in Box 1. You may deduct expenses such as cleaning cost, washing, electricity, etc. from the rental income. But you will be required to add 70% of your net income to your income taxes under Box 1.
However, it may still be worthwhile to rent out your house/apartment to cover parts of your housing costs. Also, if you are FI, and receive little to no income from other sources that would be taxed in Box 1, these income streams may still be very interesting as various deductions on low incomes will drop the effective tax rate below the above noted 25%.
Passively Investing in Real Estate
If you have an property management company look after the property/properties for you (and yes, you pay a fair amount of money for this, but besides some tax advantages it also provides risk management and peace of mind). Your real estate ventures, with regards to taxation, are considered in Box 3. The good thing here is that you are taxed on net wealth (i.e. market/assessment value minus mortgage/loans). Initially, when your mortgage or loan is generally high (say 70%), the remaining (say 30%) of the value of the property is added to your wealth and taxed at an effective rate of 1.2% (for 2015 and 2016, in 2017 this may increase). If you make about 4% on the property value after costs (this includes the cost for property management, mortgage, maintenance, etc.). Your effective tax rate of only 9%, that is a lot more reasonable (4 times actually) than 36% as noted above!
For example (optimistic view, granted):
- Your property is worth €200.000
- Your mortgage is €140.000
- Your wealth for taxation is considered at €60.000
- Yearly taxation (assuming your net wealth in Box 3 is between €25.000 and €1.000.000, the tax man assumed 4% return and 30% taxation on that assumed return) is €720
- Based on the assumed 4% ROI (net, so after all costs including those for management) on property value, your yearly income will be: €8.000 (based on your actual investment the ROI is actually 13%, which is on the high end of what is possible in the Dutch market)
- Effective taxation in Box 3: 9%
Contrary to “actively real estate investing” in Box 1, in Box 3 you are not able to deduct any expenses (e.g. maintenance, property management fees, etc.), because the taxation is done only on an assumed rate of return on your net wealth, and these expenses are not take into consideration.
Now, before you start calling the property management firm, you have to do your own calculation to see if the additional costs of the property management is still allowing you to generate sufficient cash flow to be able to pay the mortgage, property taxes, insurance and allow excess cash for maintenance and mishaps.
Our real estate investments are actually managed by an investment company to assure our taxation is considered in Box 3, as this is financially the most interesting option for us. That being said, our effective tax rate is not as low as 9% as noted in the above example, but more in the order of 20%. That is still a lot of taxation, but still warrants management by a firm rather than by ourselves.