Life Insurance as Financial Instrument Deductible?

When financing the purchase of a real estate or something else likewise costly, a life insurance can be an item needed to secure your loan from the bank. Normally, costs of a life insurance are only a personal deductible and have no influence on your profit from business or the surplus of your income over the expenses from renting. The Federal Tax Court gave its decision to this issue on February 25, 2009 (re IX R 62/07).

Johnny wanted to purchase real estate to later rent it out. In order to finance the buildings, he took out a loan. In order to secure the loan, he simultaneously closed a life insurance with a minimum duration of 12 years. The benefits form the life insurance were assigned to the bank. In order to come up with the life insurance premiums, Johnny took out another loan which resulted in payments of over € 5,000.

The tax court considered the interest of the loan financing the premiums for the life insurance as a private costs which are not deductible (§12 no. 1 EStG). The court considered the interest as part of the financial plan and therefore a operational deductible. Deductibles pursuant to §9 I 1 EStG are expenses in order to achieve, secure, and maintain income from renting. This is also applicable for interest from loans when it has an economical relationship with a source of income (§ 9 I 3 no. 1 EStG). When such is the case, insurance premiums will not be considered as a personal deduction (§10 I 1 EStG). Interest must be a cause of obtaining income - here from renting. This is the case, when a loan is really used to achieve income, especially to finance the purchase price of real estate. Ruling case law also determines that not alone a legal relationship (like as a security for a loan) will suffice just as little as the purely mental determination "as for income purposes" of the tax payer.

So when the purchaser of real estate closes a life insurance to secure the loan financing the estate, the premiums will never be an operational deduction - so ruling case law. It is something else, however, in the case of interest when it is used to finance the premiums via a loan and belongs to a financial concept. While the insurance premiums remain as private expenses, the interest from the loan can be considered as an operational expense because they are part of the financing. When a loan is taken out exclusively to finance a life insurance then it is aimed paying back the loan for the sales price of the real estate. When the house is financed short-term with life insurances and no deduction of interest from the loans for the insurance is possible, the BFH considered this as an unreasonable encumbrance of one's freedom to finance projects.