For inheritance and gift tax purposes, residential rental properties are valued using the standardised income approach pursuant to Sections 184–188 of the German Valuation Act (BewG) . The starting point for the calculation is the so-called gross income – generally the actually agreed annual rent. But what applies if this rent deviates significantly from the local market level? The BFH ruling of 5 December 2019 (Case No. II R 41/16) has provided a precise answer to this question for practical application.

The case

The proceedings concerned the valuation of a residential rental property where the actually agreed rent deviated significantly from the rent index. The tax office did not apply the contractual rent but instead corrected it to the "customary rent". At issue was how the threshold for this correction should be calculated – in particular, whether the mean value of the rent index or the outer bounds of the rent index range should be used as the benchmark.

The decision

The BFH confirmed the view of the tax authorities and established the following principles for practical application:

Basic Rule: Gross income is the actually agreed annual rent payable for the letting of the property.

Correction Threshold: If the actual rent deviates by more than 20% from the local market level, the customary rent must be applied instead of the contractual rent.

Benchmark: The reference point to be used is not the mean value of the rent index, but the lowest value (in the case of rent that is too low) or the highest value (in the case of rent that is too high) of the rent index range. All values within this range are considered to be at the local market level – the 20 percent threshold is only measured outside this range.

This interpretation prevents even minor deviations from the mean value from triggering corrections and is aligned with the purpose of the provision: to counteract abusive structuring arrangements without unduly complicating the standardised valuation procedure.

What This Means for Valuation Practice

For heirs and beneficiaries of gifts whose properties are valued using the income approach, the decision has concrete implications in two directions:

Rent Too Low: Old contracts with rents far below market level lead to a correction to the customary rent – but only once the rent falls more than 20% below the lower bound of the rent index. Anyone inheriting a residential rental property with heavily discounted long-standing tenants should keep this threshold in mind.

Rent Too High: Short-term inflated rents do increase gross income – but likewise only up to the 20 percent threshold above the upper bound of the rent index. Amounts exceeding this are capped.

In both cases, it is worthwhile to check whether the actual gross income has been correctly applied – an incorrect gross income base carries through the entire income approach and can lead to a significant shift in the building's income value.

Conclusion

BFH II R 41/16 brings clarity to a practically relevant detail issue in the income approach: the 20 percent threshold for gross income is not measured against the mean value of the rent index, but against the outer bounds of the rent index range. Anyone inheriting or receiving a residential rental property as a gift and wishing to review the tax valuation should carefully verify this approach – errors in the gross income figure carry through the entire income approach.