In a concerted effort to bring down prices in the residential real estate market, the Israeli Government has recently implemented a number of reforms in the regulations connected to real estate transaction taxes (purchase tax and capital gains tax in Israel). While most professionals in the field would agree that the reforms have not achieved the desired effect of an overall lowering of prices, the changes have affected the bottom line for many buyers and sellers.
Much discussion is devoted to mas rechisha (purchase tax), but what about mas shevach—the tax that is applied to any capital gain or profits generated as a result of selling a property in Israel? Will you be taxed on the sale of your asset? And if so, by how much?
What is Mas Shevach?
Mas shevach is “capital gains tax” in Israel, also known as “appreciation tax”, since the capital gain to be taxed is determined by calculating the difference between the shekel value of the initial purchase of the property and the shekel value of the sale after accounting for the effects of inflation in the interim period. If no capital gain is made, no tax is payable.
Historically, property owners in Israel were granted an exemption from this tax on the sale of a residential property once every four years, without restriction as to how many properties were owned by the seller. This means that a person could own several properties, sell one every four years and enjoy an exemption on each sale. This allowed many real estate sellers or investors in the residential property market to enjoy significant profits on their investments and enabled families to use the profits from a property sale to upgrade their home.
Changes in capital gains tax in Israel as of January 1, 2014
As part of the tax reform of January 1, 2014, this exemption has been cancelled and the new rules have significantly altered the situation for sellers. As a result, if you are selling a residential property, you may be required to pay tax on the increase in the value of your property of up to 25%.
For the purposes of understanding your exposure to capital gains tax, January 1, 2014 is the all-important date. The main points of the new tax regulations, in summary, are as follows:
- If you are NOT an Israeli resident, you are not eligible for an exemption from capital gains tax. This holds true even if you own only one residential property in Israel. Non-residents are, however, eligible to use the Linear Tax Rate (see explanation below).
- If you ARE an Israeli resident, you are eligible for an exemption from capital gains tax subject to the fulfillment of all the following conditions:
- You currently own only one property in Israel (for the purposes of this calculation, any property in which you own at least a third of the rights is counted).
- From the date of January 1, 2014 onwards, you owned only one property at a time and you have owned that property for at least 18 months before selling. For newly constructed apartments, the 18 months is calculated from the time that construction is completed.
Exceptions: If you receive an additional property by way of inheritance, this will not disqualify you from being eligible for the exemption upon the sale of your first property, subject to certain conditions regarding the inherited property. Additionally, if you own two inexpensive apartments, both of which you are selling in order to purchase one larger residence, you may be able to claim an exemption in certain circumstances.
- The value of the sale does not exceed 4.5M NIS. If the value is higher, you will have an exemption for the first 4.5M NIS and the difference will be taxed at the Linear Tax Rate.
- The property being sold was not received as a gift. If it were a gift, additional restrictions would apply when calculating eligibility for an exemption from capital gains tax.
Important note: The tax regulations specifically refer to Israeli residency and not Israeli citizenship. The definition for residency is set forth in the income tax laws, meaning that your “center of life” must be in Israel, you must spend at least 183 days of the year in Israel and you may not claim the exemption as a foreign resident on your income tax filings. In addition, all exemptions relate to the sale of residential properties. As a rule of thumb, if you are selling land or commercial property you cannot claim an exemption from capital gains tax.
Obviously, for many sellers, especially those who had purchased additional properties for investment, the loss of the exemption from capital gains tax severely reduces the financial gain of a potential sale. In an attempt to soften the blow, the Government included a provision known as the Linear Tax Rate which is currently in effect through December 31, 2017.
Linear Tax Rate
According to the Linear Tax Rate, the seller is not taxed on the full amount of capital gains accrued, but only on the relative portion of the gains from the date of January 1, 2014 until the date of the sale. The Linear Tax Rate can be utilized by both resident sellers and non-resident sellers and can be used twice, subject to certain conditions. This rate cannot be used on the sale of properties to family .
For example, if a property was purchased on January 1, 1995 and sold on December 31, 2014 for a profit of 1M NIS, the tax authority would calculate the full gains (1M NIS), divide it by the number of years which elapsed between the date of the purchase and the date of the sale (20 years), calculate the relative gain for each year (50,000 NIS) and multiply that by the amount of time between January 1, 2014 and the date of the sale (1 year). Thus, in our example, on a gain of 1M NIS, only 50,000 NIS would be taxed at the capital gains tax rate (25%).
Additionally, other factors are taken into consideration which also may reduce the tax, as the taxable gain is calculated after deducting certain expenses such as agents’ fees, lawyers’ fees, purchase tax, capital improvements to the property, etc., and is adjusted for inflation.
The Linear Tax Rate significantly reduces the capital gains exposure for any seller selling a property which was bought before Jan. 1 2014, but is not beneficial at all for sellers who do not have an exemption and are selling properties bought after this date.
One thing is clear: the tax regulations are getting more and more complicated. Please consult an experienced lawyer who specializes in residential real estate law when contemplating any real estate transaction in order to properly assess your exposure to tax.
Jane Olman, Adv. is a partner at the law offices of Rachlin & Olman in Jerusalem, where she specializes in Israeli real estate law. With more than 20 years’ experience, Jane has earned an unappareled reputation in guiding English-speaking clients through the legal processes in Israel. She can be contacted at [email protected]