How to reduce taxes on rental income in CH?

Real Estate
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Dear Mr. MP,
I have been following your post for years. However, until now, I never really felt the need to create an account as I didn’t really have questions to ask. Today, I have created an account because I really need some specific advice and I am unable to find anyone around me giving me in-depth advise on this matter.

Here’s the decision I am hoping to conclude: Should I sell my rental property with 8.81% gross return before taxes and invest it in S&P500 instead as I am paying very high taxes on my rental income today.

Details:
Mrs. FIP and I own a rental property in Vaud and our ROI (investment = downpayment, and in return, I am counting the mortgage amortization as I consider that money building my equity. I am of course not considering any gain in value of the property in this.) is 8.81%. I am unhappy with it because we are paying high tax on our rental income here (of course some basic expenses reduced), whereas if we were to make a company that owns the same property, we will be paying 13.79% in taxes and that is almost half in my case.

My conundrum here is that if we were to create a company - I have talked to my tax guy and my notary and they are telling me that if I were to withdraw dividends from this company I will end up paying tax then. Ideally, if everything goes well with our jobs, I do not need to withdraw dividends from this company. So making a company makes sense only when I am withdrawing the dividends from this company once my regular income from the job has gone down significantly i.e., FIRE achieved because otherwise I will end up paying my regular tax rate on the dividend income and in that case I would have been double taxed (first on the company’s 13.79% and then on my regular tax rate). Therefore, the advise I’ve got so far from my sources is that just for one or two rental properties, there is no point making this company.

My sources also started scaring me with things like that I will have to pay 3.3% (of the value of the property) tax in transferring the property in the name of this company - which is true but I’d rather pay something like that for once than pay regular income tax for 15+ years. Then forming a company will be about 2k, and then maintaining the books and filing taxes for this company will be another 2k per year and then also, I will be taxed 13.79% on the profits. I was also told that if I leave a lot of money (money remaining in the company = earned rent - expenses and bank payments (interest + amortisation)) in the company - the company will be taxed differently as the tax authorities multiply the cash available in the company with a multiple to calculate the tax owed by the company.

Yet, somehow, I don’t buy this entire storyline that I have been given from my sources as it seems too pessimistic and not creative enough to be able to find ways to pay less tax, create wealth from real estate. This storyline goes in the direction of forcing me to pay high taxes, and somehow accept that a real estate with a ROI of 8.81% (before tax) remains an underperforming asset. Yes, it is an underperforming asset the moment I consider the tax, but if I can reduce the tax significantly, I believe it is not so bad (yes, it will be lower than S&P 500 any day if I don’t consider the value that this property might gain over a decade).

Ideally, I’d not only like to create this company but also have this real estate company invest its money through IBKR into the S&P 500 to further use the rental yield to be invested in stocks. Ideally, I would also like to acquire more rental properties as I have my eyes on another one that has a 12% ROI but I won’t do it if I continue to pay high taxes the way I am doing today :frowning:

The big question remains - Is it worth making this company financially? If so, for your real estate firm, how do you plan to withdraw the money once you may need the money?

Last but not least, I am totally open to selling this property if you think that this property is an underperforming asset and invest that money on the S&P 500 instead. The difference is significant as the S&P 500 has given 8.8% return consistently over the last 65 years, is much more liquid and I will only be paying a wealth tax there which is much lower than my rate of income tax. However, I really want to explore the real estate company route before I sell my property as ideally I should wait a few years before I should sell this property to make some considerable capital gains.

Eager to have your view!

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A good tax expert will be able to run simulations comparing direct vs indirect real estate (including the one off cost of transferring the property to the company, recurring yearly costs etc.) ownership and the overall impact on taxes (individual taxes, company taxes, shareholder taxes).

A tax expert can help you structure the company to allow tax-free distributions to shareholders and/or optimise the company’s tax position (creation of reserves, shareholder loan).

Once you’ll have all the data at hands, it’ll be easier to opt for the best scenario.

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Two points to consider from pure financial perspective leaving aside the asset allocation strategy

  • expected total returns of S&P 500 in CHF terms shouldn’t be assumed more than 4-5% . In fact if you look at report front Vanguard, it’s even lower.
  • when you compare these investments , you need to compare total expected returns i.e Rental income + capital appreciation of RE vs. total expected return of S&P 500 (dividend + capital appreciation)
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This sounds like a multi asset fund in the end and would go into realm of Corporate taxation. Highly recommend to consult corporate tax experts

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I think you’re focusing too much on the tax, a 12% return sounds amazing, even if you’re taxed 50% marginal tax rate, I bet you can’t find a reliable 6% tax free return that easily.

(and if you retire, etc. I assume your marginal tax rate will go down, or you could just move to a canton with lower taxes, etc.)

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I agree on not focussing on the tax. If 50% tax is too high, just earn double the income and you get the same net return as 0% tax.

Shelter what you can with usual stuff Pillar 2, Pillar 3a. For the rest, pay the tax and build a bigger income so the post-tax income is what you need.

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Very cool. :sunglasses:
This morning after I posted this, I spent some time creating scenarios and it seems clear. If I have 2 or more rental properties, a company makes sense. Else, just for 1 - it’s buff buff :drooling_face:
Clearly, my current tax advisor feels this is too complex. Do you have any recommendations how to find a good tax advisor?
Thanks again for your response.

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That’s very smart! :sunglasses:
In fact, for my S&P500 portfolio, I have been considering a 4-5% return because of the currency exchange rates and CHF has gained value over time. So yes, you’re right, 8-12% return in CHF is not bad! Thank you so much :star_struck: for pointing out something I knew technically but never really looked at it like this. This is super helpful.

And yes, I am being very conservative with my real estate as I am not considering the capital appreciation of the asset for now. Super! This is reassuring. :yum:

Do you have any recommendations how to find a good tax advisor? :thinking:

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This won’t help regarding the tax question or the question of creating your own company but may help regarding holding real estate vs simplifying the portfolio to hold only stocks and bonds.

Trying to simulate real estate with other asset classes, I came to the conclusion that unleveraged real estate is roughly 35% stocks, 40% intermediate term investment grade bonds and 25% cash. That was using backtest porftolio, so US data, to be taken with a grain of salt.

Assuming 35% equity in the home (no amortization), I would compare your expected real estate returns with a leveraged portfolio of:

100% stocks
114% bonds
-114% cash (debt)

If you are comparing it with a unlevered portfolio of just 100% stocks, the real estate investment should have a small edge on returns (the difference between bonds and cash) but also hold more risk (leverage vs no leverage).

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For tax advices in Romandie, you can contact Berney associés

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You are welcome.

Regarding tax advisor, I don’t have any contacts for Corporate taxes. Perhaps someone else in this forum can recommend.

In general expected real estate returns on average are lower than equities if one were to buy a property without leverage and rent it out. But at individual asset level, this can vary a lot because of location, leverage ratio, mortgage rates, maintenance costs, rental laws etc.

One comment on capital appreciation
I once saw a video where a large real estate owner (Grosvenor) in London said that in very long term real estate value appreciation should be similar to salary increases for people who live there. Otherwise who would pay for it :). In short term it can do lot of random things like we saw in last 10 years.

Last point -: it seems you are quite disappointed with taxation :wink: but what matters in the end is total return (income + capital appreciation) post tax.

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I think what your tax advisor has told you sounds correct, there is no loophole to dodge the taxes by creating a company, only to defer the taxes

That sounds really high in the current market where 2-3% is more like the norm. How come? Are you calculating it on the market price or historical price paid(?)

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Hi @Barto ,
I am calculating it on the price from 2020, when we bought the place. Our cash down including the Notary was 147k, and we are making a rent of 24k on this. Then I deduct maintenance charges being paid to the building and the interest paid on the loan but I add the amortization as that’s money finally going in our pocket (whenever we make an exit). The interest back in 2020 was 0.75% and that helps. I hope this helps.

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Gross return is calculated as: annual rental income divided by value of the property.

Cash down is not relevant to that calculation, so maybe your 8% figure is actually a cash-on-cash return calculation?

A 8.81% gross return on 24k annual rent implies a property value of 272k.

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Yep. It is cash on cash return. You’re right.

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To be able to give an opinion it would be important to know your estimated net yield on the asset, before you apply financial engineering (your loan)

Gross yield = gross rent / current market value

Net yield = (Net rent after repairs & maintenance and allowance for vacancies) / current market value

For rent of 24k, no. The hassle and fixed costs make it not worthwhile, in addition you are likely only deferring the taxes, not avoiding them.