Property depreciation in Israel: allocation of the purchase price of your apartment.
Calculating real estate depreciation in Israel: When a company or individual acquires real estate (apartments, stores, business premises, offices), they must divide the acquisition value between the land and the building.
The stakes are high, since the land, unlike the building itself, is not depreciable. In other words, the part of the land related to the investment cannot be deducted for tax purposes, as it is not linked to the depreciation of real estate in Israel.
For a long time, it was common practice to value land at 1/3 of the purchase price. But this "quick fix" calculation can run a significant tax risk.
So, how do you calculate real estate depreciation in Israel? We take a look in this article.READ ALSO: HOW TO CALCULATE TAX ON PROPERTY INCOME IN ISRAEL
Purchase price allocation: an accounting requirement
Companies and private individuals need to divide the acquisition cost of a fixed asset between its various components. In the case of real estate, this involves dividing the cost of construction between different elements, such as roofing, structure, electrical installation and waterproofing. The tax authorities provide a number of indicative scales that can be used.
However, this breakdown by component also implies dividing the acquisition cost of a property between the building and the land.. This breakdown is particularly important because, unlike building components, land cannot be depreciated.
So, when rental income is high, the customer may tend to minimize the price of the land, and make the "built" part more important. As a result, the deductible portion will be higher and taxable income will be lower.
No official scale, but a "broad scope" of application
Ideally, in the case of a purchase, the sale price should be broken down in the notarial deed. In practice, this is rarely the case. The chartered accountant who monitors this type of file and has to record the acquisition must therefore turn to other sources of information to arrive at a breakdown that best reflects economic reality.
The tax authorities do not provide any construction/land rates, even for guidance. Given this lack of information, many practitioners have got into the habit of using a lump-sum valuation of 1/3 of the total price for the land. However, this assessment can easily be called into question by the authorities, particularly in areas where property prices are high.
The price of a plot of land in Tel Aviv or Jerusalem is not the same as in Hadera, so it's obvious that the allocation can be challenged by the tax authorities.
The landowner then runs a significant tax riskIn this case, the tax authorities may revalue the price of the land and, consequently, reject any unduly applied depreciation.ALSO READ: Form 5329 - Declaration of sources of income in Israel
Common practice in Israel
Methods used by the Israeli tax authorities to challenge the taxpayer's breakdown.
These methods are as follows:
- priority, analysis of purchases of bare land made at similar dates in the same geographical area as the property: this is the comparison method;
- by default, calculating the cost of rebuilding the buildingcorrected for obsolescence and state of repair;
- and, as a last resort, a reconciliation with the breakdown used in other operations for comparable properties acquired at similar dates in the same area.
These methods and their order of priority are binding on the tax authorities when they intend to contest the taxpayer's assessment.. The taxpayer, for his part, can criticize the method used or justify his own assessment by referring to other data, but he cannot use methods other than those recommended by the Israeli tax authorities.
It is common practice in Israel to consider the non-depreciable part of the land at 1/3 of the price paid in the major cities and 1/4 of the price in the suburbs.
The Israeli tax authorities reserve the right to counter this position, as explained above.
Only the purchase value is to be divided between the non-depreciable land and the rest of the property.
Other types of expenditure are amortized using other calculation systems. Please do not hesitate to contact us.
Which method to choose?
Unlike the tax authorities, taxpayers rarely have access to consolidated data enabling them to analyze purchases of bare land made under the same conditions and in the same geographical area as their own property.
Calculating the cost of reconstruction, on the other hand, requires a certain knowledge of the real estate and construction markets, and even the services of an expert. However, when properly executed, it has the advantage of being difficult to contest.
In fact, this is our preferred method, because thanks to our partners, we have access to a wide range of experts who can attest to the figures we have selected. Don't hesitate to consult us if the tax authorities try to challenge your position.
What are the consequences?
- The higher the depreciation rate, the lower the book profit, and therefore the lower the tax you pay.
- Note that when you resell, the depreciation already booked will be deducted from your purchase value, so the capital gain will be even greater.
Our firm specializes in tax optimization for this type of project. Don't hesitate to call on professionals in the sector.
Your questions - our advice
- Does this law apply to gifts of apartments between relatives?
- Is it compulsory to depreciate the asset on resale, even at the flat rate of 10%?
- Is there a difference between residential and commercial property?
- How many years back can the taxman go?
- How much capital gains tax is payable on resale?