Property owners renting their apartment in Central Eastern Europe have a tax liability in the country where the real estate is located. We differentiate between corporate and private ownership in Hungary. In case the owner is a company, all the expenses connected to the operation of the company are deducted from the total income, VAT is handled separately, and the company is taxed at a 16% corporate tax rate on profits. Generally, as with companies everywhere, there is much more room to “optimize” the tax at the end of the year, than in the case of private ownership. Establishing a company is not required; non-residents may own property directly without any restrictions in Hungary. Properly maintaining a company is time consuming and costly, so most foreign investors of apartments in Budapest are individual owners.

The governing document regarding taxation of non-residents is the agreement to prevent double taxation between Hungary and the investor's country of residence. In most cases this document prescribes taxation in Hungary when the property being rented is located in Hungary. Later this tax may be deducted from a similar category of personal income in the country of residence.

There are three ways of calculating and paying income tax on rental. The first method, called Source Tax, is simply deducting 25% of the rental income, submitting a tax return, and making the payment every quarter. The second method, called Combined Income Tax, deducts 10% as expenses and the remaining 90% is taxed at 17%. In the rare case that annual income exceeds 5 million HUF (18,500 EUR), the tax bracket is 34%. The third method, called Thorough Expense Reporting, allows the investor to deduct all relevant expenses, after which the remainder is taxed at 17%.

Before we examine each of these options, let us determine what the income and expenses are. Accountants do not agree about the nature of utility expenses, whether they are included in the rental income, thus are taxable, or not. Let us work with the worst case scenario and count the electricity, water, gas, and common cost expenses as part of the rental income. Later we will see how they can be deducted as expenses. Expenses may be any money spent on the apartment, as long as it is backed up by invoices.

Source Tax

Those apartment owners who want the least hassle have the option of simply paying 25% of the total rental income every quarter as income tax. No expenses can be deducted whatsoever. The income is immediately taxed at its source, hence the name.

Combined Income Tax

There is an option of paying significantly less tax if one declares the rental income as part of the combined personal income in the country. The law states that if expenses cannot be determined accurately when renting an apartment, there is a fixed 10% which may be deducted from the tax base as expenses and the rest is taxed according to the applicable tax brackets. There are only two tax brackets, 17% and 34%, the threshold being 5 million HUF between them. So unless the rental income exceeds 1540 EUR/month, the tax is 17%. Since only 90% is taxed, the rate is effectively 15.3% of the total income. Note that other sources of income in the country, if any, must also be declared.

Thorough Expense Reporting

There is an option to further reduce the tax base, although there are additional accounting expenses. If all the expenses can be justified with the relevant invoices, there is an opportunity to write off much more than the fixed 10% suggested above. The property management fee itself is 10%, to which we add VAT and we are already in this category. Property management fee, tenant finding fee, costs of furnishing and renovation, as well as the utility bills and the interest paid on a bank loan can all be offset against the rental income. The items must be approved by the accountant individually to determine whether they would stand in case of a tax audit. What remains is taxed at 17%. Therefore theoretically in the end the income tax may be pushed down towards 10%. Here again the 5 million HUF threshold pushes us up into the next tax bracket.

The deadline for submitting the tax returns and paying the income tax for the year 2009 is May 20, 2010, in case of private ownership.

There is no need for non-residents to pay an additional 14% Health Subsidy (EHO) on top of the personal income tax. Hungarian citizens are obliged to pay this health tax, which apparently discriminates between Hungarian and non-Hungarian apartment owners, giving a market advantage to the foreign investor.

In order to start the process one has to obtain a Tax ID (adoazonosito) as well as a Tax Number (adoszam) from the Tax Authority (APEH). The Tax ID registers the investor as a tax payer in Hungary. The Tax Number refers to the specific activity of renting real estate. The investor may rent his/her apartment only after the Tax Number is issued. There is an obligation to issue monthly invoices either from a numbered invoice pad or a computer program registered with the Tax Authorities. Copies of these invoices, along with invoices (not receipts or bills) of expenses, form the basis of the annual or quarterly tax returns. It is highly recommended to employ professionals to handle the paperwork properly, who have the relevant liability insurance and competence to handle issues promptly and accurately.

It is fairly common and legal in Budapest to rent an apartment in a residential building as commercial premises, for example a lawyer's office or a marketing agency. In case the apartment is rented to a company, a monthly tax advance must be deducted from the rent. Reference to this must be included in the rental contract and the tenant (the company renting from the foreign private investor) must pay the tax advance regularly. In case tenant fails to pay the tax advance, it will be held liable, not the apartment owner.

Andras Patkai www.ceinvest.hu