Introduction: Challenges of Investment on Third-Party Property
When a limited liability company (LLC) constructs a business property on land owned by private individuals, both accounting and tax-related questions arise. The property is registered under the private individuals’ names on the title deed, but the investment is carried out by the LLC. How should this be handled in the company’s books? Should the company issue an invoice to the owners, or treat the costs as fixed assets? Below, we outline the possible solutions, considering the provisions of the Hungarian Accounting Act (Szt.) and tax regulations.
Legal and Accounting Background of the Investment
When an LLC, acting as a lessee, constructs a building on land owned by private individuals (with their written consent), it constitutes an investment on third-party property. The parties must document in a written lease agreement what happens to the investment upon termination of the lease. For example:
- The lessor purchases the investment.
- The lessee sells it to another lessee.
- The lessee is required to restore the original condition.
The terms of this agreement determine the accounting and tax procedures.
Accounting Treatment: How to Record the Investment?
According to the Hungarian Accounting Act (2000. évi C. törvény, Szt.), investments on leased property must be recorded in the lessee’s (LLC’s) books, similar to owned assets (Szt. 26. § (2)). This means that activated investments or renovations on leased property should be recorded under real estate.
Exceptions: Sale to the Lessor
If the lessee sells the investment to the lessor, the LLC issues an invoice, and the investment’s value is recorded in the lessor’s books as an increase in the property’s value. Since the lessors in this case are private individuals, this accounting step does not apply to them.
Maintenance vs. Investment
- Maintenance costs: These are expensed in the business year they are incurred.
- Investment costs: Costs related to expanding, altering, or extending the lifespan of the property are accounted for under the rules for investments on leased assets.
Useful Life and Residual Value
When activating the investment, determining the useful life and residual value is critical:
- Fixed-term lease: Align the useful life with the lease term, assuming zero residual value if no agreement exists on the investment’s fate.
- Indefinite lease: Set the useful life based on the remaining life of the property.
Tax Implications
The fate of the investment upon lease termination has significant tax implications. Below, we examine the three most common scenarios:
1. Sale of the Investment to the Lessor
If the lessor purchases the investment, the LLC records it as a fixed asset sale (Szt. 77. § (3) e)). For corporate tax purposes:
- Revenue from the sale increases the tax base.
- For fixed-term leases, the residual value is based on the amount paid by the lessor.
VAT: The sale of real estate is governed by the VAT Act (2007. évi CXXVII. törvény, Áfa tv.) 86. § (1) j). If less than 2 years have passed between the first use and the sale, the transaction is taxable. If the LLC opts for VAT liability, the sale is taxable regardless.
2. Free Transfer to the Lessor
If the lessor does not pay for the investment, the LLC records its book value as other expenses (Szt. 81. § (2) p)). From a VAT perspective:
- If the LLC previously exercised VAT deduction rights, a VAT liability arises under Áfa tv. 11. § (1), with the tax base being the market value (or book value if market value is indeterminable).
3. Restoration of Original Condition
If the LLC is required to restore the original condition, the investment’s residual value is recorded as an extraordinary depreciation (Szt. 53. § (1) b)) and removed from the books. Restoration costs are expensed in the year incurred.
- Corporate tax: Extraordinary depreciation increases the tax base (Tao tv. 8. § (1) b)), but removal may reduce it (Tao tv. 7. § (1) d)).
- VAT: Scrapping does not trigger VAT liability if properly documented (e.g., scrapping protocol).
Practical Advice
- Lease Agreement: Clearly define the investment’s fate (sale, free transfer, restoration).
- Documentation: Ensure scrapping or transfers are supported by documents (e.g., protocols) for tax audits.
- VAT Deduction: Verify whether the LLC exercised VAT deduction rights, as this impacts VAT obligations.
Conclusion
Accounting and tax treatment of investments on third-party property is complex but manageable based on the lease agreement and the parties’ decisions. The LLC can record the investment as a fixed asset, but the sale, free transfer, or restoration carries different accounting and tax consequences. Always consult an accountant or tax advisor for accurate bookkeeping!
Related Articles:
- Fixed Asset Accounting: What You Need to Know
- VAT Rules for Real Estate Investments
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