Key drivers for the increased relevance of the so-called “Co-Ownership Funds” are the current uncertainties of an upcoming reform of the German law on partnerships ("MoPeG") as of 2024 for German real estate transfer tax treatment. This structure can be an attractive alternative for structuring the contribution of real estate into a fund solution in Germany, for both economic and tax reasons.
1. Introduction / set-up of a Co-Ownership-Fund
According to German law, a German open-ended real estate special fund (Immobilien-Sondervermögen) can generally be structured in two ways: (1) the real estate will be legally owned by the investment management company on behalf of the real estate special fund/its investors (so-called “trustee solution”) or (2) by the real estate special fund’s investors themselves (i.e., in the case of a single investor, ownership or title in the real property or other assets remains with the sole investor - the so-called “Co-Ownership-Fund” - Miteigentumsfonds).
The Co-Ownership-Fund can be used as a fund vehicle for the optimization of German real estate held by (institutional) investors on their balance sheet directly.
For the set-up of a Co-Ownership-Fund, the investor contributes (German) real estate (and, for example, fixtures or shares in real estate holding companies) to the Co-Ownership-Fund. “Contributes” means in this respect that only the sole power of disposal (Verfügungsmacht) with regard to the real estate will be transferred to the Co-Ownership-Fund’s investment management company. The legal ownership of/title in the contributed real estate remains with the investor (i.e., there is no legal change of ownership/title in the land register). In return, the Co-Ownership-Fund’s investment management company issues shares in the Co-Ownership-Fund to the investor, of which the value is determined based on a valuation of the contributed real properties. There is no capital flow required for such contribution transaction.
With regard to German corporate income tax (“GCIT” - Körperschaftsteuer) and German trade tax (Gewerbesteuer) (if applicable) a disclosure of hidden reserves of the real estate will take place upon contribution, which generally triggers an income taxation of those (latent) capital gains. However, for tax-exempt investors such as German occupational pension schemes, the contribution of the real estate won’t be subject to German corporate income tax nor German trade tax based on their individual tax-exempt status.
Moreover, according to a ruling of a lower fiscal court in 2016, the contribution of real estate to the Co-Ownership Fund does not trigger German real estate transfer tax (“RETT” -Grunderwerbsteuer) which has been the qualified tax position of King & Spalding since 2010. However, given that there has been no final decision of the German Federal Fiscal Court (Bundesfinanzhof) as the highest fiscal court in Germany and no official circular or decree has been issued in this regard by the German Ministry of Finance yet, there remains a certain residual risk.
2. Benefits of a Co-Ownership-Fund
The Co-Ownership-Fund can be used as an appropriate tool to leverage hidden reserves of the contributed real estate for balance sheet effects, utilize available and accrued tax loss-carried forwards, bundle real estate (for example: transfer from investor’s “own balance sheet”) and perform a transparent and up-to-date valuation of these real estate assets. By transferring the sole power of disposal with regard to the contributed real estate to the investment management company, the investor’s asset management responsibilities (for example: tenant management etc.) can be outsourced to the investment management company and thus maintain the investor’s own resources. Moreover, should a replacement of the investment management company be required for whatever reason, no German RETT will be triggered. Other benefits can include, for example, flexibility in distributions based on the applicable fund calculation schemes or a potential use for compensation in relation to negative performance of other investments of the investor.
3. Potential structural advantage of a Co-Ownership-Fund due to changes in German law on partnerships as of 2024
Compared to the legal structure of the German investment limited partnership (Investment-Kommanditgesellschaft) which is commonly used as a closed-end fund entity to pool real estate, we currently see an important advantage with the Co-Ownership-Fund model:
Due to still missing and —from our perspective —clearly required changes in German tax laws to prevent (unintended or intended) detrimental tax effects by the reform of the German law on partnerships as of January 2024, this new legal framework could have a massive impact on the RETT treatment due to the new recognition of legal capacity for the partnership itself, which means that it can hold assets in its new capacity and such assets are no longer considered "joint assets of the partners” (Gesamthandsvermögen). Under the current RETT system, exactly this system of the Gesamthandsvermögen allows an ultimate release from a RETT burden on the contribution of the contributed real properties if the investors stay within the partnership for at least ten years with their initial interest holding in that partnership (mandatory holding period).
Thus, without an adjustment of German tax law in due time, the contribution of real estate of an investor to a German investment limited partnership potentially will trigger real estate transfer tax as of January 2024, even if the investor had owned the real properties before and already holds 100% of the interests in the investment limited partnership.
Regardless of the above mentioned current RETT uncertainties, the Co-Ownership-Fund can be an attractive alternative for structuring the contribution of real estate in a fund solution in Germany for both economic and tax considerations. This investment tool is applicable without restrictions both to domestic and foreign investors.