Investing in Real Estate: What is a “Real Estate Deficit”?

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Little known but easy to use, a real estate deficit allows you to reduce the overall amount of tax you pay when you invest. The idea is to buy an old apartment, renovate it, rent it out and reduce your tax bill!

By deducting your real estate “charges” from the amount of rent you’re receiving from letting out an apartment you’ve renovated, you can create a real estate deficit. In turn, you can deduct this amount from your other taxable income up to a limit of 10,700 euros per year. What happens if you’re living abroad? No problem. This method of reducing the amount of tax you pay is also open to non-residents. If you invest in real estate in France, you can therefore reduce the amount of tax you pay, as well as building up a worthwhile estate.

What’s more, if the real estate deficit measure is so popular, it’s because it offers numerous advantages to anyone looking to invest. First of all, real estate deficit is not a classic tax incentive measure. It was first introduced in 1993 as part of the Balladur Law – which comes under general law – and which is going to be around for many years yet! Next, contrary to the tax reduction measures under the Pinel, Duflot or Scellier Laws, real estate deficit applies to older apartments which represent higher guaranteed rental returns.

How can I take advantage of the real estate deficit measure?

There are four conditions which must be satisfied if you want to benefit from the real estate deficit measure: the apartment you purchase must be an old one, the renovation works you carry out must be sufficiently extensive to qualify for real estate deficit, the apartment must be let out for an uninterrupted period of at least 3 years and finally, the apartment must be let out unfurnished. You must also adopt the “as paid” tax regime on your real estate income and ensure that the works you have carried out count as renovation works. Rebuilding or extension works do not count and cannot be taken into consideration for real estate deficit calculations. Lastly, you must be sure to keep all your invoices relating to the works to be able to provide proof for the tax authorities.

How is real estate deficit calculated?

The formula is fairly straightforward. You just deduct the expenses and charges attributable to the apartment in question from the amount of rental income you’ve received. Expenses and charges that can be taken into account are many and varied: charges related to co-ownership, management expenses, real estate tax, expenses relating to mandatory surveys, interests on mortgages and, of course, maintenance and renovation works.

If the cumulative amount of such expenses and charges is higher than the amount of rent you earn, the difference represents your real estate deficit. This is the amount you can then deduct from your taxable income – up to a limit of 10,700 euros. You cannot, however, deduct the portion corresponding to the interest you’ve paid on your mortgage from your taxable income, only from your real estate income.

Let’s take the example of a French expat living in New York who has chosen to invest in an old apartment in Paris. They carry out 32,000 euros worth of renovation works and pay real estate tax in an amount of 1,350 euros. Co-ownership charges amount to 1,200 euros and our expat has also paid 16,000 euros of interest on a mortgage. They have earned a total of 14,000 euros in rent.

Our expat’s deficit is therefore 36,550 euros (50,550 – 14,000 = 36,550).

This deficit is made up of 2,000 euros of interest on the mortgage (14,000 – 16,000 = 2,000).

The French expat in question may therefore deduct 10,700 euros from their taxable revenue. They may also deduct the remaining 25,850 euros from the real estate income they earn over the following 10 years.

How can a real estate deficit help us save money?

The higher the level of tax you pay, the greater difference this tax reduction tool will make. Let’s take another look at our French expat who has invested in an apartment in Paris. If they are paying tax at a rate of 41%, they can save 4,387 euros of tax on their taxable income starting in the first year (10,700 x 0.41). The remaining 28,850 euros of their real estate deficit will cancel out the 14,000 euros of real estate revenue earned the following year then the 14,850 euros earned the year after that.

It is important to remember that tax authorities treat fees on any loans slightly differently. These are not included in initial calculations to determine whether or not you are in a deficit situation. If all your other deductible charges allow you to be in a deficit situation, any mortgage-related expenses will be added to the total. Failing that, they will be carried over to the following year.

The real estate deficit tool makes it possible, therefore, to invest in real estate in Paris, for example, and pay less tax. A win/win situation for our expat.