Americans wishing to invest in residential real estate in Israel should consider both the US and the Israeli tax implications of their investment. While Israel imposes different taxes on foreign investment in Israeli real estate, the US has a policy of taxing its citizens on worldwide income and reserves the right to disregard most provisions of the tax treaty for this purpose (see article 6(3) of the US-Israel tax treaty). Since the tax treaty gives the right of first bite to Israel on income from real estate located in Israel, we will first consider the Israeli taxation of these investments and will then discuss US taxation and general tax planning strategies..
Israeli tax considerations
Foreign investors wishing to buy Israel real estate property should be aware of the following local taxes: purchase tax, appreciation tax and income tax on rent.
- Purchase tax (mas rechisha) is imposed upon acquisition of the real property. The purchase tax rate on non-Israeli investors for 2016 is set at 8 percent on the first 4,896,615 NIS (approximately $1,255,000) of the purchase price and 10 percent on the remaining portion of the price. Olim chadashim within the first 7 years after making aliyah are entitled to lower tax rates on purchase tax: 0.5 percent on the first 1,734,225 NIS (approximately $444,600) of the purchase price and 5 percent on the remaining portion of the price.
- Non-Israeli investors must also pay appreciation tax (mas shevach) at the rate of 25 percent of the value of the property upon sale. Israeli residents, including olim chadashim, can claim an exemption from this tax if they owned only one property for at least 18 months and the selling price did not exceed 4.5 million NIS. This exemption is not practically available to non-Israeli investors, as the Israeli tax authority requires a confirmation from the local tax authorities that the taxpayers do not own other real estate property in their country of residence. This documentation is rarely issued by foreign tax authorities.
- Regarding the taxation of rental income, both Israeli and non-Israeli taxpayers can choose between three taxation regimes:
- Tax exemption of up to 5,030 NIS per month and payment of marginal tax on the taxable portion starting at 31 percent (this exemption only applies to taxpayers who own only one property).
- Payment of a flat 10 percent tax on all rental income.
- Payment of regular Israeli marginal tax rates after claiming deductible expenses. These rates for 2016 are 31 percent for annual income up to 237,600 NIS, 34 percent for additional income up to 496,920 NIS and 48 percent on the remaining income. Taxpayers who are at least 60 years old are entitled to lower tax rates.
An Israeli tax return must be filed with the Israeli Tax Authority to report rental income and pay Israeli income taxes due. Individual investors using regime #2 will not be required to file an Israeli tax return if their only income is from rents and their annual rental income does not exceed 334,000 NIS. They must pay the tax either on a monthly basis or within 30 days after the end of the tax year. A special short form is used for this purpose.
US tax considerations
Rental income is taxed in the US at ordinary marginal rates (which range from 10 percent to 39.6 percent). Expenses that can be deducted against this income include mortgage interest, depreciation on the property for 27.5 years, and all other expenses that are related to the maintenance and rental of the property. In addition, a foreign tax credit can be claimed for Israeli income taxes paid. Purchase taxes paid upon acquisition of the property must be added to the cost basis of the property and depreciated over 27.5 years. Rental income and expenses must be reported in Schedule E of the taxpayer’s US tax return.
Non-Israeli investors who sell their home (sole property) after more than one year normally will not need to pay US long-term capital gains tax, as they can claim a foreign tax credit for Israeli appreciation tax paid on the sale.
Tax Planning Strategies
Special consideration should be given to the method of taxation for rental properties. Taxpayers investing in several rental properties can choose between regimes #2 and #3 on each property individually.
Another important tax planning area is the estate tax. Israeli real estate property owned by a US citizen is subject to both US estate tax upon the death of the owner and Israeli appreciation tax when the property is eventually sold.
An Israeli-American tax professional should be consulted in advance to avoid unexpected tax consequences in both countries. We recommend that you bring to the meeting information on the value each property, mortgage documentation, and estimated rental income.
The rates and amounts listed in the article are only applicable to 2016 and are subject to change in the future.
Natan Savransky has been involved in the international tax field for over ten years. His professional experience includes managing audits of several high-tech companies, structuring complex transactions, and providing comprehensive tax advice to investors in the U.S. Nathan is fluent in English, Hebrew and Spanish and can effectively communicate across cultural boundaries. He can be reached by email at [email protected]