Real Estate Investment in the Czech Republic: Legal Framework & Business Entity Options

Milan Laufik

As a hub of commercial, cultural, and tourist activity, Europe has traditionally attracted foreign investors. For the American investor seeking a favorable investment return, the Czech Republic has become an appealing option in the heart of Europe. This article examines the legal framework which governs the Czech real estate market.

A number of factors make the Czech real estate market desirable to the American investor. First, Czech real estate rules, codes, and customs are similar to those in the United States. The American real estate investor can thus navigate the legal niceties of the Czech market with relative ease. Second, the United States and the Czech Republic signed an agreement, which decreases an American investor’s tax obligation in the United States. Any income tax liability incurred by an American investor in the Czech Republic can be used as a credit against tax liability in the United States.   

Finally, the Czech Republic is a member of the European Union (“EU”). As such, it will likely adopt the EU’s common currency, the Euro. Though a debated issue, the Euro could very well stimulate the Czech economy and, as a concomitant result, the Czech real estate market. The economic impact of the Euro, however, is outside the scope of this article.       

      In light of the foregoing, this article will provide insight into the practical aspects of investing in Czech real estate. It is written from the point of view of a lawyer and businessman who grew up in Czech society and who, as a naturalized American, has experienced the pleasures and disappointments of investing in a mixed-use property[1] in central Prague.  

This article will highlight some of the most important legal and economic differences between the Czech and American systems, within the following categories:

A)   Benefits of investing in the Czech real estate market;

B)   Current state of the Czech real estate market;

C)    Setting up a real estate business in the Czech Republic;

D)   Financing a Czech real estate investment;

E)    Tax implications of investing in Czech real estate;

F)    Real estate services, which are unique to the Czech Republic; and

G)   Potential pitfalls of investing in Czech real estate.

A)          Benefits of investing in the Czech real estate market

As discussed above, an American investor benefits from the significant overlap between Czech and American real estate rules and the lack of double taxation. Tax payments on all Czech income, whether from real estate or other sources, result in a credit on United States income tax payments. Furthermore, Czech property tax rates, when compared to property tax rates in the United States, are exceptionally low.[2] All together, the Czech Republic offers significant financial advantages.

Demand for Czech real estate is strong. Situated in the heart of Europe, the Czech Republic offers an excellent location. It is close to many popular tourist destinations and travel within the country is facilitated by an exceptionally advanced transportation network. The capital city of Prague is renowned for its historic castles, churches, and landmarks.

Demand for Czech real estate is bolstered by a strong economy and ample business opportunities. The Czech Republic has invested significantly in education, innovation, and research and development. Considered the skills hub of Central Europe, the country has a technically-educated workforce, which is motivated, responds well to training, and costs a fraction of western labor. In addition, eighty percent of Czechs can speak a foreign language.

Supported by its capable workforce as well as government initiatives, the Czech Republic has also become an innovation hub. The Association of Innovative Entrepreneurship conducts research and development to support technology and innovation. The Investment Incentives Act, put together by the Czech government to attract foreign direct investment, provides foreign investors with significant tax relief and grants for job creation and training. The Operational Programme Enterprise and Innovation helps connect the research and business sectors.

            All of the aforementioned factors increase the value of commercial and residential real estate in the Czech Republic. Financial advantages, excellent location, and strong demand allow commercial real estate investments to meet their monetary objectives. Similarly, those who seek an improved quality of life may invest in residential real estate and enjoy proximity to popular European destinations, excellent transportation, and rich economic opportunities.[3]

B)           Current state of the Czech real estate market

To acquire Czech real estate and enjoy its many benefits, an American investor must complete some relatively manageable steps. An American investor must first create an American company and then establish a subsidiary or branch in the Czech Republic. This subsidiary or branch can then be used to purchase Czech real estate. 

Recent empirical evidence suggests that demand for Czech real estate is increasing. During 2014, the average price of apartments in the Czech Republic rose by 2.74%. In 2014 as a whole, developers sold a record 6,000 new apartments in Prague, which exceeds the pre-crisis levels of 2007.

Healthy demand for Czech real estate continued in 2015. During the first quarter of 2015, mortgage approvals increased 28% as compared to the first quarter of 2014. Further, apartment sales increased 37% during the first quarter of 2015 vis-à-vis the first quarter of 2014.

Recent demand for Czech real estate is attributable to increased interest from foreign homebuyers, low interest rates, and increasing confidence in the Czech economy. The Czech Republic’s GDP growth was 2% in 2014, up from 0.7% in both 2012 and 2013.

C)        Setting up a real estate business in the Czech Republic

As previously discussed, an American investor can acquire Czech real estate by establishing a company in the Czech Republic. The investor can choose from four different types of companies: 1) limited liability; 2) joint stock; 3) limited partnership; or 4) general commercial partnership.     

i.               Limited Liability Company

Small and medium sized businesses commonly opt to establish a limited liability company. The registered capital of a limited liability company is composed of shareholder contributions. At least 30 percent of subscribed monetary contributions must be paid before the company is registered with the Commercial Register.   

A limited liability company does not issue shares. The size of an ownership interest is determined by the ratio of a shareholder’s investment contribution to the company’s registered capital.

D)         Financing a Czech real estate investment

An American investor may finance a real estate acquisition by registering capital through cash or in kind contributions. Such equity financing may occur at incorporation or subsequent to incorporation, when the registered capital is increased. Real estate can also be financed through shareholder or group loans, loans from banks and other financial institutions, or leasing of fixed assets. The Czech banking system is generally business friendly and provides helpful customer service throughout both the loan underwriting process and the loan management process.

            E)        Tax Implications of Investing in Real Estate in the Czech Republic

i)               No Double Taxation

            In an effort to promote investment in the Czech Republic, the United States and the Czech Republic entered into a Tax Convention on January 1, 1993. This Convention seeks “the avoidance of double taxation” as part of “the continuing effort of the United States to expand economic relations with the Czech Republic.” Under Article 24, Section 1, “the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income the income tax paid to the Czech Republic by or on behalf of such resident or citizen.” Therefore, any income tax liability incurred in the Czech Republic (which includes deductions for property tax payments) can be used as an income tax credit in the United States.

 

ii)         Taxes associated with Equity Financing

            The Parent-Subsidiary Directive went into effect on May 1, 2004. Pursuant to the Directive, a dividend payment - from a qualifying real estate company to a qualifying Czech intermediate holding company or a qualifying EU investor - is not subject to withholding taxes. If the Directive is not applicable, then dividends – which are paid to both domestic and foreign participants - are taxed at 15%.

iii)        Taxes associated with Debt Financing

            If a lender and borrower are related parties, the interest on loans used to acquire real estate is generally tax deductible. However, the interest rate on the loan must be the result of an arm’s length transaction. The deduction may be taken during the period when the interest was accrued, regardless of when the interest was paid. A domestic withholding tax of 15% applies to cross-border interest payments from a Czech real estate company to a foreign entity, unless a relevant tax treaty reduces this rate.

iv)              Corporate Income Taxes

Czech companies must pay a tax on their worldwide corporate income. The corporate income tax base equates to accounting profit or loss, adjusted in accordance with the Income Taxes Act. This tax obligation may be reduced by deducting expenses incurred to generate, maintain, and/or assure taxable income. Examples of these types of deductible expenses include building depreciation, reserves for building repair, real estate taxes, real estate transfer taxes, and interest on loans that are used to finance real estate purchases. As a general rule, all transactions with related parties must be conducted at arm’s length.

v)               Value Added Tax in the Czech Republic

All EU member states are required to adopt a Value Added Tax (“VAT”), which complies with the EU VAT Code. The VAT is a consumption tax on the value added to goods and services. The Czech Republic, as a member of the EU, imposes a 21% VAT on the vast majority of goods and services. However, different rates of VAT apply to certain categories of goods and services, such as groceries and medicine.   

The VAT is not assessed on the acquisition price of real estate, but it does apply to real estate management. Owners and tenants must pay VAT on goods and services related to real estate operations. Owners must reconcile VAT payments with the Czech government on a regular basis.  

 

F)         Real estate services, which are unique to the Czech Republic

The Czech real estate industry has not yet developed escrow or title insurance services. In lieu of escrow services, Czech attorneys undertake the complicated process of securing funds, transferring title, and closing real estate acquisitions. As a substitute for title insurance services, the Czech Land Registry verifies and registers property ownership records. 

G)          Potential pitfalls when conducting Czech real estate operations

 “Good Soldier Svejk” is widely recognized as a national hero of Czech literature. He was a folksy character who would extricate himself from difficult situations by outsmarting others with wit and humor. Because Good Soldier Svejk’s influence on Czech culture was so pervasive, some of his methods and style have subtly influenced Czech real estate practices.

The Czech real estate market can create significant challenges for the unsuspecting American investor. Some of the major pitfalls may occur during the processes of property acquisition, property due diligence, and/or property management. Although these pitfalls are relatively rare, they can create significant complications and should therefore be kept in mind.

When evaluating a property, a potential buyer may spend significant time researching, analyzing, forecasting, and making calculations. All of these administrative efforts may prove to be in vain when, as sometimes is the case, the advertised price is not available and, as a result, the property is no longer desirable. Other surprises may be lurking behind the corner. The previous owner of a building may have worked with major tenants to manipulate existing rental prices, in order to increase the building’s capitalized value. This type of manipulation would be difficult to detect because market studies are often not available.  

The process of due diligence can also create challenges. After completing a purchase, a new owner may find that major defects have been woven into a structure’s design. The defects are difficult to detect through public inspection or the buyer’s due diligence.

A new owner may also encounter surprises during property management. A corporate tenant may unilaterally decide to reduce the amount of rent due under a lease. A tenant may also simply walk away from a lease.

The American investor may try to use the Czech judicial system to enforce a contract or to recoup damages. However, many people find that the judicial system is complicated, inefficient and, in the end, ineffective at providing a remedy. If the judicial system indeed proves futile, an American investor can hire a private enforcement company to help enforce a contract. The company will use techniques such as visiting the workplace or residence of a person who has engaged in unfair real estate practices. The company will threaten to publicly disclose the unfair practices in order to compel compliance with a contract.

In light of the foregoing, the Czech real estate market can create significant challenges for the unsuspecting American investor. Careful selection of real estate counterparts is therefore essential.

 

  

 

[1] A property with multiple uses, whether as a residence, office space, and/or commercial entity, is mixed-use.

[2] Czech property tax rates are as low as $1.00 per square meter.

[3] The preceding discussion applies most directly to the cities of Prague and Karlovy Vary, which bring in significant tourism and, as a result, increased real estate demand. The real estate market in other Czech cities, such as Brno or Ostrava, usually does not generate a sufficiently high rate of return.