Exemption of income spent on own housing and deduction of mortgage interest in tax return
- Vladimír Toráč
The Czech Income Tax Act offers taxpayers a relatively wide range of exemptions from personal income tax on the sale (transfer) of immovable property. One of these options is the exemption of income from the sale of immovable property, in which the seller has not resided for at least 2 years immediately prior to the sale, but uses the proceeds to provide for his own housing needs. In this article, we would like to focus on this possibility, among others.
As of 1 January 2021, article 4b of the Income Tax Act (“ITA”) introduced a new administrative obligation, namely the taxpayer’s notification obligation when claiming exemption from income on the sale of immovable property. If the taxpayer fails to notify the tax administrator of this fact by the end of the statutory deadline for filing the tax return, he cannot use this income tax exemption.
The Finance Ministry does not require the taxpayer to submit this notification on any specially prescribed form. In order to claim the exemption from income tax on the sale of immovable property, it is sufficient to notify the respective tax office in a general letter.
Conditions for exemption
Exemption of the income, which is conditional on the taxpayer spending the funds obtained from this income to provide for his or her own housing needs, shall apply if the taxpayer notifies the tax administrator of the acquisition of these funds by the end of the deadline for filing the tax return for the tax year, in which they were acquired. If we are currently speaking about the tax return for 2021, the deadline for filing the notification will thus expire on 1 April 2022, or 1 July 2022, if the taxpayer is represented by a tax consultant before the tax administrator.
The law requires a taxpayer, who submits the following notification to the tax administrator,
a) to use the proceeds to acquire his or her own housing needs by the end of the tax year immediately following the tax year, in which the taxpayer acquired the proceeds (e.g. proceeds from the sale of an apartment acquired in 2021 can be used to acquire other housing needs until the end of 2022),
b) to use an amount corresponding to the funds received for his own housing needs before the funds were received, but no earlier than in the tax year immediately preceding the tax year, in which the taxpayer received the funds. In other words, the exemption of income e.g. from the sale of an apartment in 2021 can also be applied to retrospective cases, where the taxpayer acquired another apartment in the past, for example in 2020.
If the above-mentioned conditions for the exemption of this income are not met (i.e. the funds are not used for the acquisition of own housing needs in the relevant tax year), the income from the sale of immovable property must be taxed under article 10 of the ITA in the tax return. If the taxpayer used the funds for other housing needs only partially, the income is exempt only to the extent of the funds used for his/her own housing needs and the remaining part of the income is considered taxable income under article 10 of the ITA.
Partially tax-exempt income
The taxpayer bought an apartment (unit) in Jičín for CZK 2,600,000 in spring 2020 due to a favourable job offer, but he only lived there for one year. In the spring of 2021, he sold the apartment for CZK 3m and moved into a house in Prague with his girlfriend. He uses half of the sale price (CZK 1,500,000) for the purpose of maintenance and alteration of the house (this purpose falls within the scope of housing needs under article 4b paragraph 1 of the ITA), and uses the rest to help pay off his sister’s mortgage loan.
The condition of previous residence for at least two years in the property being sold is not met for the purposes of the tax exemption, so in this case only that part of the income from the sale of the flat, which the taxpayer used to acquire new housing needs – i.e. the funds which the taxpayer invested in the maintenance and alteration of the construction of the family home – can be exempted. The other half of the income, even though it will be spent to provide for his sister’s housing needs, does not meet the condition for exemption and is thus taxable income from the transfer of immovable property for consideration under article 10 paragraph 1 letter b) item 1 of the ITA. In the same proportion, i.e. 50%, the tax expenses related to this taxable part of the income must be reduced, which will be in particular the proven purchase price of the sold apartment unit in Jičín, i.e. one half of CZK 2,600,000.
Therefore, the taxpayer will be obliged to submit personal income tax return for 2021,
- where he will report a partial tax base of CZK 200,000 (CZK 1,500,000 – CZK 1,300,000) for other income according to article 10 of the ITA,
- and to notify the tax administrator of the use of half of the income realized from the sale of the apartment for the acquisition of housing needs.
Reduced limit for application of the interest on a loan for housing
With the entry into force of Act No. 386/2020 Coll., which repealed Senate Act No. 340/2013 Coll., on the tax on the acquisition of immovable property, the tax on the acquisition of immovable property was repealed and changes were made to the ITA. The change in this law significantly reduces the limit for tax application of interests on a home loan. From the original amount of CZK 300,000, the limit has been reduced to CZK 150,000.
According to the new law, the legal regulation of interest on loans applies only to loans acquired by the taxpayer after the amended law had come into force. The new legislation will therefore only apply to loans acquired by the taxpayer on or after 1 January 2021. On the other hand, if the taxpayer obtained the loan before 1 January 2021, the limit of CZK 300,000 may be applied even after the amendment to the Income Tax Act becomes effective.
Below we add some practical situations that may arise with the change in legislation. The Coordination Committee of Tax Advisors discussed these examples with the General Tax Directorate of the Czech Republic.
The taxpayer enters into a mortgage loan with a bank on 5 October 2020 for the construction of a house. The plot is owned by the taxpayer. The first activities aiming at the acquisition of the immovable property consisting in the preparation of an architectural study and subsequently the construction and technical documentation for the application for a building permit were carried out on 10 November 2020. The first part of the funds was sent to the taxpayer’s account on 15 December 2020 when the land was pledged to the bank. The first construction work began on 20 January 2021. On 20 May 2021, the gross building height reached one metre, and on 15 June 2021, a proposal for entry of the partially constructed house into the Land Register was filed. Entering of the ownership right will be allowed on 25 June 2021 retroactively as of the date of filing the application for the entry (i.e. 15 June 2021). The construction of the house will be completed on 31 December 2022.
For the purpose of assessing this example, the decisive point in time for the acquisition of the housing need will be the date the building permit is issued. If the building permit is issued on 31 December 2020, the interest limit will be CZK 300,000; if it is not issued until 2021, the taxpayer will be able to deduct interest on the mortgage loan from the tax base only up to CZK 150,000 per tax period.
The taxpayer plans to renovate the family home he inherited from his parents in May 2018. He has prepared an architectural study for the renovation and entered into a contract with an architect on 1 November 2020. On January 8, 2021, the taxpayer entered into a mortgage loan with a bank for the purpose of maintaining and altering the structure of the house. The funds will be disbursed on 30 January 2021. The first construction work will start on 10 February 2021 and the entire reconstruction will be completed on 5 January 2022.
Since the activities aimed at carrying out the reconstruction began on 1 November 2020 and have continued continuously since that date, the concept of the acquisition of a housing need – maintenance and alteration of the construction of the family house – financed from the subject of the loan until the end of 2020 has been fulfilled, so the taxpayer will be entitled to deduct the interest on the mortgage loan from the tax base under the old legislation, i.e. up to a maximum of CZK 300,000.
The opinion of the GFD concluded in this case that the decisive the decisive moment of acquisition of housing needs will depend on the date when the reconstruction actually physically started and it is up to the taxpayer, what document he will prove this fact to the tax administrator with – e.g. the beginning of work by the supplier proven with a contract for work etc.
Income from the sale of an investment apartment
Finally, for the sake of completeness, we add that with effect from 1 January 2021, the legislator has extended the time test for the exemption of income from the sale of immovable property, in which the taxpayer has not had a residence for at least two years immediately prior to the sale and where he does not use this income to acquire new housing needs – the so-called investment flats.
The time test has been extended to 10 years in these cases and applies to immovable property acquired after 1 January 2021.
Author: Vladimír Toráč