Abolition of rental value: What the reform really means for asset owners

The reform does not simply abolish a tax. It redefines what is deductible.

The abolition of the rental value for the main residence automatically leads to the disappearance of the related deductions, in particular:

• maintenance costs (actual or flat-rate);
• mortgage interest on the main residence.

For owners of older properties, those who regularly incur significant maintenance costs, or those with a substantial mortgage debt, the loss  existing tax deductions may outweigh the benefit of abolishing the rental value. Conversely, owners with little debt or whose main residence does not require significant maintenance costs are mostly winners. In this context, taxpayers whose rental value is higher than the sum of their mortgage interest and maintenance costs should benefit from the reform.

Expenses and interest related to rented properties remain deductible in principle, provided they are linked to taxable property income. In the case of other assets (securities), they will only be deductible in proportion to the value of the property assets in relation to the total assets.

The logic is therefore reversed: it is no longer ownership as such that gives rise to deductions, but the existence of taxable income to which these expenses can be economically linked.

This is not a property reform. It is a reform of private debt.

One of the least discussed effects of the reform concerns the deductibility of interest expenses in the broad sense.

Until now, private interest expenses have been a well-known tax optimisation lever, whether they are linked to:

• Private loans
• Intra-family loans
• Financing of financial investments
• Portfolios financed by Lombard loans

Now, the deductibility of interest expense is severely restricted and largely depends on the existence of rented property located in Switzerland. Interest related to the principal residence or any other asset except for rented property in Switzerland loses much of its tax efficiency. For example, until the reform came into force, a stock market invester (who did not own an investment property or their main residence) could deduct interest expenses linked to a Lombard loan, for example, from their investment income. Once the reform comes into force, the deduction of such interest will no longer be permitted.

Debt is therefore no longer tax neutral. Whereas it previously allowed taxpayers to reduce their tax burden regardless of the asset being financed, taxpayers must now own rental property in Switzerland, otherwise the interest is no longer deductible (and in any case, only partially deductible if the taxpayer owns other assets).

For many taxpayers, this means rethinking financing arrangements that were previously perfectly acceptable. Depending on the circumstances, it may be worth considering transferring securities and related debt to commercial assets (direct or indirect).

The real winner of the reform is not the owner, but the asset that generates income.

The reform introduces a clear distinction between three categories of situations:

• The main residence, which becomes a comfort asset, but largely devoid of tax interest
• Investment property, which retains its tax consistency thanks to the maintenance of deductions linked to rental income
• Financial assets financed by private debt, which become more costly from a tax perspective

Swiss taxation is thus evolving towards a more economic than patrimonial approach: income-generating assets are recognised, while others are much less so.

Winners and losers of the reform

(subject to individual analysis)

Although each situation must be analysed on a case-by-case basis, certain profiles are already emerging relatively clearly.

Potential winners:

• Owners of primary residences with little or no debt
• Owners of recent properties requiring little maintenance
• Taxpayers whose wealth strategy relies little on private debt
• Investors focused on properly structured yield-generating real estate

Potential losers:

• Owners of older properties with high maintenance costs
• Taxpayers with high levels of debt on their primary residence
• Entrepreneurs and investors using private loans or wealth financing not linked to property income (interest expenses will only be deductible in proportion to these assets relative to rented Swiss property assets)
• Holders of financial portfolios financed by private debt
• Owners of investment properties with wealth composed of other assets

Between these two categories, there are many intermediate situations, particularly for mixed assets combining primary residences, rented property and financial investments.

Practical checklist for entrepreneurs and asset holders

This reform does not necessarily require immediate action for everyone, but it almost always warrants advance analysis.

Some key questions to ask yourself:

• Is my level of debt still appropriate in the absence of tax benefits?
• Are my interest expenses linked to assets that generate taxable income?
• Does my main residence currently generate a net tax cost?
• Are my asset structures still appropriate under the new framework?
• Should certain trade-offs be considered before the reform comes into force?

Conclusions

The abolition of rental value is the visible part of the reform.

For entrepreneurs and asset holders, this reform requires a review of financing, debt and asset holding strategies. Anticipating these effects makes it possible to avoid tax surprises and, in some cases, to identify new room for manoeuvre or asset restructuring opportunities.

Author: Emilien Gigandet