By decision of 24 February 1999 (case no. IV B 73/98), the Federal Fiscal Court (Bundesfinanzhof) made an early but still valid ruling on the allocation of purchase prices for rental properties: the income approach is a recognised and appropriate method for determining the value shares of land and buildings. It is not not comparable to the "residual value method" rejected by the Federal Fiscal Court. This decision thus laid the foundation for the later openness to different methods in the case law on purchase price allocation.

Background: The problem of allocation methodology

When an investor acquires a rental property, only the building portion can be depreciated – not the portion attributable to the land. If the purchase agreement does not provide for a separate allocation, the value ratio must be determined appropriately. For a long time, it was unclear which methods were permissible for this purpose.

The so-called residual value method – in which the land value is deducted from the total purchase price to obtain the building value as a "residual" – had already been expressly rejected by the Federal Fiscal Court: it leads to inaccurate, arbitrary results because the total purchase price need not be the sum of the individual values.

The decision

In the case at hand, the taxpayer had used the income approach to allocate the purchase price for a property acquired primarily for rental purposes. The tax office rejected this, arguing that the income approach was comparable to the rejected residual value method.

The Federal Fiscal Court rejected this argument:

1. The income approach is a recognised valuation method. It is regulated in the Valuation Ordinance (Wertermittlungsverordnung), follows a transparent algorithm, and produces objectifiable results. It has nothing in common with the residual value method.
2. The residual value method is not the same as the income approach. The residual value method estimates the building value as the arithmetic difference between the total purchase price and the land value. The income approach, on the other hand, calculates the building's income value from the capitalised net income – independent of the transaction price. Both methods are fundamentally different.
3. Suitability for rental properties. For properties acquired primarily for their rental income potential, the income approach is particularly suitable because it reflects the economic value of the building as an income-generating asset.

Significance and classification

IV B 73/98 is the historical original source establishing that the income approach is fundamentally permissible for purchase price allocation. The decision paved the way for the entire subsequent line of case law:

• BFH IX R 12/14 (16 September 2015): Contractual purchase price allocation fundamentally binding
• BFH IX R 38/17 (29 October 2019): ±20% range as standard for arbitrariness
• BFH IX R 26/19 (21 July 2020): BMF working aid cannot replace the contract
• BFH IX R 12/21 (20 September 2022): Free choice of method – no priority for the cost approach