What is the total excess
Hobby in tax law
Activities that are not expected to generate any profit in the medium to long term
Activities that are not expected to make a profit in the medium to long term fall under the term "hobby" and are irrelevant for income tax. That means losses must not be offset with other income. If, in exceptional cases, a profit is made, this is not taxable.
In terms of sales tax, these activities are also attributable to privacy, i.e. the income is not subject to sales tax and input taxes are not deductible.
If a taxpayer makes sustained losses, the tax office first checks whether there is any intention and possibility of making an overall profit with this activity. A basic distinction is made between:
- Activities that are caused by the objectively understandable intention to achieve an overall profit and for which it is assumed from the outset that there is a source of income, such as: commercial operations
- Activities that are presumed to be a hobby.
- Special case "large rental": This includes the rental of at least three residential units, provided that no apartment is owned or a similar legal position exists. The most important example is the rental of rental houses.
The operation or partial operation, in the case of renting the rental house or the individual condominium, is used as the assessment unit.
1. Activities with the assumption of a source of income
The intention to make a profit is checked according to the following objective criteria:
- Extent and evolution of losses
- Relation of losses to profits
- Causes of the losses in relation to comparable farms
- behavior in line with the market with regard to the services offered and the pricing
- Type and extent of efforts to improve the earnings situation (e.g. marketing measures)
Whether a total profit was actually achieved within a foreseeable period of time is irrelevant if the losses were caused by unforeseeable events ("imponderables") and the criteria test reveals an intention to make a profit.
A's catering establishment is located on a main road. The number of visitors is falling due to the construction of a motorway. Despite a longer period of loss, the operation of the A cannot be judged as a hobby if it behaves in line with the market and, for example, tries to address other visitor groups.
Cessation and transfer of business
If the activity is stopped prematurely as an economic reaction to normal risks and unforeseen events (“imponderables”), this has no impact on the assessment as a source of income. A hobby can only be assumed if private motives are decisive. The same rules apply to the donation or sale of the business. Basically, the assessment is made separately for the seller and the buyer.
In any case, there is a source of income within a start-up period of three calendar years, starting with the year the company opens (exception: it is certain from the outset that the activity will be terminated before a total profit is made).
The start-up phase begins when expenses are incurred for the first time. It is extended by the preparatory phase up to a maximum of 5 calendar years. The start-up period continues with the transfer of the business if the activity is continued in the same form by the purchaser.
In terms of income tax, there is a cessation of business for the calendar year in which the activity is to be assessed as a hobby for the first time, at the earliest at the end of the start-up phase, without any retroactive effect on previous periods. See also our brochure Business Sale and Closure.
In terms of sales tax, there is no hobby for activities with the assumption of a source of income.
2. Actuations with hobby assumption
- Management of assets that are particularly suitable for use for private purposes: e.g. horse breeding, rental of sports aircraft, yachts
- Activities based on a private inclination: e.g. as a hobby painter, writer, private business broker
- Rental of single and two-family houses, condominiums, bungalows etc. ("small rental")
If losses occur in these activities, hobby is to be assumed from the beginning, both in terms of income tax and sales tax.
A source of income can only be assumed if it is proven by means of a forecast calculation that a total profit can be expected in a foreseeable period of time. There is no rigid time limit for operational activities, the period must be in reasonable relation to the use of funds. Only in the case of "small rentals" is the period of 20 years from the start of the rental or a maximum of 23 years from the first incurrence of expenses (reference date).
Calculation of the total profit or the total surplus
The total profit or surplus is calculated from the sum of the tax results that have already been achieved since the start of the activity and the tax results that are still to be expected (plus transitional profit and capital gains for operational activities). The tax results are to be adapted, see under “3. The big rental ”.
A bought a condominium in January 2016, which he will rent from April 2016 after the renovation work has been completed. Since he partially financed the purchase with debt, he incurred losses in the years 2016-2018, which A claimed to reduce taxes.
In 2019, the tax office asks A whether there is a hobby. A source of income is only recognized if A submits a forecast calculation which results in a total surplus for the period from January 2016 to a maximum of April 2036.
For "Exceeding the forecast values" see point 3 - the large rental.
Change of management
This is understood to mean a fundamental change in economic involvement through which the activity becomes profitable. This plays a major role, especially in the area of small rentals. A common example is the extraordinary repayment of debt, which deviates from the original plans. A change in management results in the termination of the previous activity, from this point in time it must be assessed again whether there is a hobby.
A is renting a condominium from January 2015, which he bought in 2015 and financed entirely from outside. A forecast calculation shows that no total surplus can be achieved by 2034. Renting is therefore a hobby.
In January 2020, A inherits cash, which he uses to cover the loan. A new forecast period begins in 2020. If a total surplus can be forecast for the period up to 2039, a taxable source of income is available from 2020. Nothing changes in the assessment of the years 2015-2019.
The cessation of letting and the transfer of the leased property have no effect on an earlier assessment if it can be proven that the letting was not planned from the outset for a limited period of time. It is not necessary that the trigger for the hiring or broadcast was an unforeseen event.
3. The "big" rental
Here it is checked whether a total surplus can be expected within a period of 25 years from the start of the rental, at most within 28 years (reference date) from the first incurring expenses. Only when this is the case is there no hobby.
For the calculation of the total surplus, legally limited rent is to be replaced by "normal" depreciation by customary and tax special depreciation.
If the forecast calculation does not result in a total surplus, hobby is to be assumed for income tax purposes from the start. In terms of sales tax, there is no hobby in large rentals.
If the forecast values are not reached because unforeseeable events have occurred to which the landlord reacts in line with the market, there is no hobby. If a total surplus is prevented by voluntary measures (e.g. by unnecessary repair measures), the activity is a hobby from the start.
The premature termination of the rental has no impact on the tax assessment insofar as it was caused by normal risks and unforeseeable events, such as the sale of the building due to a surprising deterioration in the landlord's financial situation. If the termination occurs through voluntary behavior deviating from the plan, however, this speaks for hobby.
4. Procedural aspects of the hobby
Since a longer period of time has to be used for the hobby assessment, the tax authorities face the problem of having to correct legally binding tax assessments.
When the proceedings are resumed, new notices may only be issued if new facts or evidence emerge that were not asserted in the procedure and that would have resulted in a different content of the notification.
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