How to Let German Tax Office Participate on the Default of a Private Loan

It is often challenging and financially problematic, if a private loan fails to be repaid. If one of our clients is in that situation, he will ask us to explain the tax effects ensuing in Germany. Here we want to explain them to you by example:

You live in Germany and you have lent a friend 40.000 € in 2010. The repayment including interest of 5% should have happened by December 31st, 2016. Now it turns out, your friend is on the brink of insolvency. He will not be able to pay back the money or just be able to pay back a small part of it.

Since the introduction of the Abgeltungssteuer (flat rate withholding tax) in 2009 capital gains and capital losses of private loans are recorded for income tax purposes. Unfortunately the Finanzgericht Düsseldorf (fiscal court in Düsseldorf) has decided by judgment of January 11th 2015 that losses on loans do not equate to sales, with the result that it is irrelevant for income tax. An appeal has been filed against the judgment.

What can you do to save a tax refund?

1. If your friend has entered insolvency you should claim that your loss on loan is taken into account for income tax. It is likely that your tax office will decline this. In this case you should object to your tax assessment and with reference to revision procedure apply for the proceedings to be suspended. This way you are able to profit from a positive BFH judgement without any financial risk.
2. If your friend hasn’t entered insolvency jet, there is a simple way to save the income tax: You sell the loan at risk of default to a third party. You will certainly find somebody who thinks he can realise 10% of the debt = 4.000 € from liquidation or by means of a settlement. Capital losses due to loan of 36.000 € are tax-deductible as losses from capital assets, but may solely be off-set against capital gains. In the best case scenario this leads to income tax savings of 25% of 36.000 € = 9.000 € plus German Solidaritätszuschlag (solidarity surcharge) and where applicable German Kirchensteuer (church tax).

If you have any questions, please get in touch with us.