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What to do when foreign property maintenance gets too pricey

After 2014, when the rouble fell against the dollar and the euro, previously bought foreign property became a burden for many Russian citizens, as the properties still require maintenance expenses in foreign currency which annually cost 1−2% of the asset value and consist of the property tax and the utility payments. Experts at Tranio.com have a few tips to share on the best strategies for overcoming increasing foreign property maintenance costs.

The owners of holiday homes abroad who have difficulties with property maintenance and want to receive an income from using them have three possible solutions to the problem:

  1. selling the property
  2. renting the property out
  3. financing it

Sale

When selling a property, you should think in advance of what to do with the money you get: you may use it to buy a commercial or a cheaper residential property, to develop a business or to invest in stocks or precious metals, among other things. In addition, you need to calculate such related expenses as the capital gains tax and the realtor's commission, which in some countries, including Hungary, Spain, the US, Turkey and Montenegro, is paid by the seller only.

The capital gains tax applies to the difference between the sales and the purchase prices and is paid once, as a rule, only in the country where the property is located. If the tax rate is higher in the country of residence, the difference is to be paid. "For instance, the tax paid by the Russian tax residents from their property sale income obtained in Spain will be taken into account when they pay their income tax in Russia, where the personal income tax rate is 13%. In some countries, the capital gains tax is not paid after several years of property ownership. For instance, this is the case when selling a residential property for sale in Germany, if 10 or more years have passed between the purchase and the sale.

However, contrary to the opinion of many investors, it is not always possible to earn when reselling. For instance, in Spain the property prices fell by 40% from 2007 and started growing only as late as 2014 such that, now, many properties sell cheaper than their purchase prices were, although the capital gains tax is not paid. For example, if in Spain a property sells for€500,000 and the capital gains is €20,000, taking into account the realtor's commission (about €18,000) and the capital gains tax (€4,800) the former owner will only get €477,000.

2010 purchase price €480,000
2016 sale price €500,000
Capital gains tax €4,800 (24% of the difference between the purchase and the sales prices)
Realtor's commission (in Spain paid by the seller only) €18,150 (3.63% of the property value, inc. 21% VAT)
Amount obtained from sale €477,050

The Russian owners of foreign property also need to know that they are required to transfer the money obtained from selling foreign property into Russian accounts; if they fail to do so, they will face a penalty equivalent to 75-100% of the property value. This can, however, be avoided: according to the law "On voluntary declaration", the currency legislation is not violated so long as the transactions are conducted prior to June 30, 2016 as part of capital amnesty and specified in a special declaration. There is yet another solution: the money can be transferred partially into a bank account, and the remaining amount can be put in the account of a foreign legal entity, notary or lawyer.

Renting out

Not all the owners who experience financial difficulties sell their properties. Primarily, this is due to the fact that the money obtained from the sale need to be invested somewhere, while the alternative investment vehicles (deposits, securities) do not have high yield rates and are at risk of depreciation as the inflation rate increases. Therefore, many people choose to rent out.

For instance, renting out a €500,000 flat for short terms in Barcelona you can not only cover the maintenance costs (about €10,000 per year) but also make a profit (about €18,000 per year).

  If the flat
is rented out
If the flat
is not rented out
Price, EUR 500,000 500,000
Cadastral value, EUR 500,000 500,000
Rental revenue, % 9 -
Rental revenue, EUR 45,000 -
Utility payments, EUR 3,475 3,475
Management company fee, % of revenue 25 -
Management company fee, EUR 11,250 -
Real estate tax (0.825%), EUR 4,125 4,125
Income tax (24%), EUR 8,100 2,400
Profit, % 6.75 -
Profit, EUR 18,050 -10,000

An advantage of this option is that, while renting a property out, people can not only cover the expenses and make a profit, but also have a rest in the flat or house they rent out from time to time.

However, if the owner lives in Russia, for example, and the property is located abroad, a management company may be needed to rent it out. In this case, the owners are usually not allowed to reside in the rental property for more than two weeks in the summer, when the tenant demand reaches its peak. In addition, in winter, when the opportunities to earn are minimal, management companies refuse to rent the property out, as a rule. As a result, the property is rented out not for the entire year, but rather 2-6 months per year. The management company fee is 20–25% of the rental income.

When rented out for short terms, residential properties deteriorate faster than vacant ones, and the owners probably will have to make cosmetic repairs more often and, subsequently, spend more.

In addition, when renting a residential property out, income tax must be paid; however, in countries such as Spain, this tax is paid even if the property is not rented out. The rate of this tax in Spain is 24% of the rental income and starts at 2% of the cadastral value if the property is not used for commercial purposes. For instance, if a €500,000 property for sale in Barcelona generates a rental income of €45,000 per annum, the tax amount will run at €8,100. If the same property is not leased, the amount will be €2,400 (if the cadastral value coincides with the market value).

Loans

If the property was bought without a mortgage, you can mortgage it and buy a commercial property, the income from which will cover the maintenance costs of both properties, with the money obtained.

The scheme should be implemented as follows: the bank provides a loan holding the existing property as collateral, the property owner uses the money obtained from the bank to buy commercial property or other assets and then he or she receives an income.

For example, the owner of a €500,000 residential property takes out a 50% LTV mortgage loan (€250,000) at 2% p.a. Then the owner uses the obtained money to pay 50% of the commercial property price, which is also €500,000. The remaining 50% of the funds the bank provides for the security of the acquirable commercial property. Commercial property yields about 5.5% per annum, and a €500,000 property will allow earning about €27,500 annually. Therefore, you may not only cover the existing property maintenance costs (about €7,000 per annum) and the loan service expenses (€10,000 per annum), but you may also make a profit (about €11,500).

  Existing residential property Acquirable commercial property
Value €500,000 €500,000
Loan amount €250,000 (50%) €250,000 (50%)
Rate 2% p.a. (with paying the interests only) 2% p.a. (with paying the interests only)
Maintenance costs €6,000 p.a. — (paid by the tenants)
Annual loan service expenses €5,000 €5,000
Annual income €27,500 (5.5% p.a.)
Annual profit €11,500

This scheme has pitfalls. Firstly, the banks can have limits on using the money; for instance, the funds can be obtained only to invest in another property, buy securities, pay for tuition or treatment or repay other loans. However, there are banks that provide general loans against existing property.

Secondly, the bank can impose limits on the property value. As a rule, the chances to obtain a loan to invest in commercial property according to such a scheme are the highest if the value of the mortgaged property is at least €500,000. The case is that the banks in Europe usually do not consider cheap property to be a security, and even if they do, their requirements are strict and the conditions are unfavorable.

Thirdly, not all the banks provide loans against existing property. Property owners are recommended to contact the European banks with which they already have an account.

Despite the fact that, when having financial difficulties the most evident option is selling the property, the most profitable one can be lending against the existing property. We recommend that foreign property owners contact financial and tax consultants in this case. Experts will help you determine the most beneficial strategy and plan how to direct the cash flow.

Yulia Kozhevnikova, Tranio.com

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