Attractive investment in property funds
Investing in indirect real estate investments is an attractive alternative to direct real estate investments for a number of reasons, including risk diversification. The main instruments used for indirect real estate investments are shares in real estate companies and units in real estate investment funds. Investing in property shares is very different from investing in property funds. Investing in units of real estate investment funds may be more attractive from a tax perspective.
The volatility of units in a listed real estate investment fund is lower than the one of listed real estate shares. The higher volatility of Swiss real estate shares is due, among other things, to the combination of daily trading, higher portfolio leverage, specific company risks and investor behaviour.
Comparing listed real estate investment funds with listed real estate companies, the average dividend yield of real estate investment funds is slightly lower than that of real estate companies. However, in terms of total return, property investment funds outperform on average in 2023. The different tax treatment can also have a positive impact on income from real estate equities and real estate investment funds.
Tax advantages of indirect property investments
Real estate investment funds or collective investments in real estate can be established in various legal forms, e.g. as a contractual investment fund or as a SICAV, as a regulated vehicle or as an unregulated L-QIF. All these collective investment schemes are treated in the same way for tax purposes. The only significant tax difference is whether the investment fund holds the property directly (direct property fund) or indirectly through a real estate company (AG).
In the case of a direct real estate investment fund, the real estate income is subject to a reduced rate of profit tax at the fund level, which generally results in lower taxation than in the case of a real estate company. Depending on the canton in which the property is located, this reduced tax rate is approximately half of the corporate income tax rate.
For tax purposes, real estate investment funds with direct property ownership generally prepare annual financial statements in accordance with the Swiss Code of Obligations in addition to the annual financial statements required by the Collective Investment Schemes Act. This ensures that depreciation is recognised for income tax purposes and that unrealised capital gains are not recognised. The taxable result at fund level is determined according to the same principles as for a corporation. A direct ownership fund can therefore control its taxable result through depreciation and provisions in the same way as a corporation, but it does not have the same leverage. The degree of debt financing of the portfolio is limited for regulatory reasons.
In the case of investment funds with indirect ownership, property income is taxed at the level of the property company at the normal profit tax rate. The taxable result is determined in the same way as for investment funds with direct ownership. However, the result can be significantly affected by maximising the interest expense on the regular loans made to the property company from the fund capital. The interest and dividends paid by the real estate company are not taxable at the level of the real estate investment fund. Rather, they are taxed at the level of the investor due to the transparent treatment.
Holding investment fund units
The Investment fund is considered transparent for income tax purposes. This means that the income and gains of the fund are generally attributed directly to the investors on a pro rata basis.
Tax aspects of an investment in Swiss open-ended real estate investment funds for private individuals domiciled in Switzerland (excluding business assets)
During the holding period, investors in an investment fund that directly owns real estate are taxed only on their pro rata share of non-real-estate related income. This is usually limited to net interest income. Real estate income that has already been taxed at fund level is tax-free for investors. Property-related income that is taxed at the level of the real estate investment fund is also not subject to withholding tax if it is distributed with a separate coupon. Depending on the canton in which the properties are located, the total tax burden can be as low as 12%, making investment funds with direct property ownership attractive.
Investment funds with indirect real estate ownership are taxed in the same way as any other securities investment fund: investors are allocated a share of the interest and dividends paid by the fund’s real estate company, after deducting administrative costs. If the property company does not distribute its profits as dividends, they are not taxed at the investor level. As a result, the taxable distribution at investor level is often limited to interest income, resulting in an overall tax burden of, for example, 25%.
Investment funds with indirect real estate holdings regularly distribute their income mainly in the form of repayments of fund capital, which remain exempt from income tax for investors (individuals). This is particularly the case for so-called distributing investment funds, which, according to the fund regulations, distribute at least 70% of the annual result as calculated by the Collective Investment Company Act (CISA) to their investors.
This CISA result is based on the consolidated financial statements of the investment fund and the fund’s property company. It regularly and significantly exceeds the net interest income generated at the level of the investment fund alone, which is attributed to the investors for tax purposes. To the extent that the distribution exceeds the net interest income earned at fund level, it qualifies as a tax-free repayment of investment fund capital. Such redemptions are very attractive from a tax perspective for private investors.
The difference in tax treatment between investment funds with direct property ownership and funds with indirect property ownership can have a significant impact on the return on an investment in property investment funds. The calculation shows, based on a simplified example, that investments in direct property funds can lead to higher returns for individual investors than investments in indirect property funds due to the lower overall tax burden. This is mainly due to the fact that returns on direct ownership are not subject to income tax at the level of the individual investor.
On the other hand, for both types of investment funds, the taxable portion of the return is often significantly lower than the tax-free portion. Investors generally receive a higher portion of their returns in the form of tax-free capital repayments. This ‘dilutes’ the difference in the overall tax burden, making indirect property funds attractive to individual investors.
Unlike investment fund units, property shares are always subject to double taxation on profits – subject to the distribution of capital reserves (e.g. from capital increases) – once at the level of the corporation and again at the level of the shareholder on the dividend. In the case of an investment fund with direct real estate ownership, profits are taxed only once at the fund level.
In addition, a listed real estate company must always distribute the same amount in the form of a taxable dividend in addition to the tax-free repayment of capital contribution reserves. This rule does not apply to collective investment schemes, and here too there is a relevant tax advantage of the investment fund unit over the share.
Sale and redemption of property fund units
The redemption of investment fund units or the sale of investment fund units gives rise to a tax-free capital gain for private individuals. Similarly, the redemption or sale of units in real estate investment funds does not give rise to any transfer tax or real estate gains tax. This is the case even in cantons that levy a capital gains tax on transactions involving even a single share in a real estate company (e.g. Vaud or Geneva), as the fund unit cannot be equated with a share.
In contrast to investment fund units, the redemption of own shares regularly has significant tax consequences.
Conclusion
Units in collective investment schemes with direct or indirect real estate holdings differ significantly from shares in real estate companies in terms of after-tax performance. In particular, investment funds with direct real estate holdings prove to be an interesting indirect real estate investment for private investors from a tax perspective.