Renting out several apartments in Israel is considered a commercial activity, with all the consequences that this implies.
The Israeli tax authorities have been targeting the owners of several apartments in Israel for several years now.
- We published the "Leshem & Biran" case law, which foreshadowed the new position of the Israeli tax authorities (see summary at the end of the article).
- The tax authorities wanted to impose a special tax on owners of more than 3 apartments, but finally changed their minds.
Now the tax authorities are focusing on landlords who rent out several apartments in Israel and requalifies their activity as a business.
The direct consequence is that the 10% tax rate would no longer apply, the tax could rise to 50% for some Israel homeowners!
This article deals only with long-term rental income. Short-term rental income is covered in the following article:ALSO READ: Short-term rental income
There are a number of questions to be answered in this article:
- What is the minimum number of apartments that must be rented for the property income to be considered "commercial" income?
- The courts have defined a number of criteria for determining whether an activity qualifies as commercial income.
- Dividing your apartments into several "small lots" requires a certain know-how and "active involvement" on your part.
Summary of the law on property income in Israel.
Normal" flat-rate taxation.
Income from rents will be added to the owner's other income, such as salaries, dividends, interest, etc.
As a result, the owner will pay taxes according to the tax brackets that apply to him or her.
In this case, you can deduct current expenses related to the rented apartment from the rent: depreciation and repairs, renovations and improvements, bank charges, lawyers' and estate agents' fees...ALSO READ: Tax brackets in Israel.
2 - Linear tax rate of 10%.
By opting for this tax package, the owner must pay 10% of the rents collected in Israel. He will also have to pay 15% of rents collected on property located abroad, outside Israel.
The special feature of this package is that no expenses can be deducted.. Neither the depreciation of the property, nor current maintenance expenses, nor even the bank charges linked to the loan for the purchase of the property.
Beware of unpleasant surprises: when you resell, the capital gain is calculated by adding the depreciation from which you did not benefit! So you pay double the tax!ALSO READ: Paying 10 % in tax is already too much!
3 - Total or partial tax exemption.
Up to a certain amount of rent, the owner will not have to pay taxes on the rents received.
This amount is reviewed every year. For the 2020 tax year, the amount is 5100 shekels per month (5090 shekels per month for 2019).
If the rent received exceeds this amount, the authorized exemption must be recalculated as follows:
- The amount in excess is deducted from the authorized ceiling, to obtain the "adjusted ceiling".
- We deduct the "adjusted ceiling" from the rent, to obtain the "taxable income".
- The resulting taxable income is taxed according to the owner's income tax brackets.
So: What's the problem for owners of multiple apartments in Israel?
The tax calculation listed in the previous paragraph concerns passive income only.
By this we mean: income derived from a low level of involvement on the part of the owner. This translates into income obtained "passively", without active involvement.
The owners of several apartments in Israel respondent at criteria that will detailed are therefore unable to take advantage of this relief and will be able to be imposed to 50%.
What criteria define whether your rental business in Israel is a commercial activity?
After a brief review of the situation, we'll look at the various criteria that the courts have chosen to requalify your "long-term rental in Israel" activity as a commercial activity.
These criteria were mentioned in the "Yaacov Arbiv v. State of Israel" case law. Netanya Tax Authority.
- Verification of the number of units rented in Israel.
- An apartment registered in the Tabo (Israeli land register) as a single unit, but which is "divided" into several lots and therefore has several different tenants. The taxman sees this as an additional indicator for reclassifying your activity as commercial:
- the number of tenants - several different contacts, with no "rental solidarity".
- The know-how of dividing an apartment into several lots to increase profitability tends to deviate towards the commercial nature of the operation.
- Improvement and embellishment of the property. (Work, major refurbishment etc...).
- Competence and know-how: the taxman could base his decision on the skills you have acquired over the years around the world (shareholders of SCIs in France or LLCs in the USA are particularly targeted).
- Number of bank loans and verification of the financing system for your apartment in Israel. Analysis of the ratio of equity to foreign capital.
- Frequency of tenant turnover.
- Use a rental management company or take personal responsibility for managing the tenant base.
ConclusionEvery criterion is important and must be taken into account. There is no "black or white" answer. Administration looks at the overall picture on a case-by-case basis.
The Israeli tax authorities may take into account the number of apartments you also own abroad to reclassify your business as commercial, and not just the assets you own in Israel. (Even during the 10-year exoration period).
Your know-how acquired abroad can work against you.
Transfer of apartments in Israel to family members: Operation in the sights of the tax authorities.
Transferring several apartments in Israel to family members does not guarantee tax allocation between them. If absolute control over the apartment rental business belongs to the relative who transferred the apartments, the tax authorities will continue to regard the rents received as belonging to the "original owner".
Jurisprudence - Mr Arbiv Yaacov case study (Sept 2019)
Together with his children, Mr. Arbiv owns ten real estate properties in the city of Netanya. The apartments were acquired by Arbiv over the years, and some have been registered in his children's names. Most of the properties have been divided into several dozen units.
Arbiv was responsible for renting and maintaining the family property. He put all the rents in his own hands and used the funds according to his own wishes.
Arbiv is awaiting criminal proceedings concerning the rental of real estate between 2009 and 2014. Arbiv is charged with various offences for failing to declare correctly and in full the income from real estate rentals in Israel.
The Israeli tax authorities claimed that Arbiv operated a residential rental business, so the provisions of the tax-exempt residential rental tax - or a tax rate of 10% - did not apply. In addition, it was argued that Arbiv should be taxed on all rental income generated by all family properties, whether or not the properties were registered in his name.
Profit from rent without declaring it for tax purposes: The taxman is waiting just around the corner.
In his annual tax returns, Arbiv only reported rental income from properties registered in his name. Rental income from properties registered in the children's names was not included.
Arbiv's reported income was calculated on a "net basis", after neutralizing charges on electricity, water and ownership of leased assets. Most income was declared as passive income taxable at the rate of 10% in accordance with Article 122 of the Income Tax Ordinance, and the remainder was subject to tax exemption.
As for the declaration of income from the rental of the properties listed in the name of Arbiv's children. It turned out that, with the exception of two children who rented additional properties themselves, the other children were entitled to a tax exemption up to the maximum income generated by the rental properties.
It was a complex set-up that was completely dismantled by the Israeli tax authorities.
Case law - Leshem and Biran case study.
In the case of Leshem and Biran, the Supreme Court ruled that the leasing of 20 to 30 real estate assets necessarily constituted an active business activity and not passive rental income.
It was stated that the focus should be on:
- The number of leased assets.
- Asset enhancement.
- The existence of a "sales process and method". (as simple as that may be).
- Size and frequency of operations required for rental.
- The owner's practical knowledge and experience.
- Expertise in this unique rental niche.
- Increased risk-taking in the same economic sector.
Consequences for the Arbiv case.
Apparently, Arbiv carried out various beautification activities on the properties before putting them up for rent:
1. Upgrade for residential use - refers to alterations made to properties that were used as warehouses at the time of purchase, and converted to residential use.
2. Residential property division - These are properties that have been purchased as whole units and divided by Arbiv into several housing units.
3. Beautifying and refreshing the property - Arbiv installed every shower room and kitchen. Arbiv either did most of the work itself or supervised it directly.
Arbiv said it had carried out "standard repairs" designed to allow tenants to reside, in line with its duty as a landlord.
For example, replacing a broken door or repairing a leaky faucet. In addition, Arbiv himself came to the apartment and collected the rent.
In this case, it has been determined that we are not dealing with the rental of nine or eleven residential apartments, but with the rental activity of a large number of sub-units, sometimes for short periods. The number of housing units is significant on any scale.
The children's property income is fully deductible for tax purposes.
The children's involvement in the acquisition of the property was summed up in the signing of the acquisition documents with a lawyer. Some of them visited the property, but this seems to have had no effect on its location and selection. Arbiv was solely responsible for managing the rental, and this was done at his sole discretion.
The court ruled that it was not necessary to completely ignore the registration of certain children's names in the land register. Nevertheless, its only interest in the fact that the apartments were in the children's names was that, in the long term, each child should receive an apartment.
Arbiv's total control over the assets and the resulting financial return leads to the conclusion that rents should be charged to it for tax purposes.
Note that simply listing the children's names is an artificial act. It is sufficient that the totality of the facts indicate the transfer of the children's assets to Arbiv, which led to the transcription of the income.
The provisions of article 84 of the CGI state that when the holder does not have the power to "regain control ... of the income or property", then the income will be considered as the income of the beneficiary.
However, it is not always when a parent acquires a property for his or her children, or is involved in renting it out, that the rental income must be personally associated with him or her.
The court ruled that the income from the rental activity would be classified as a commercial activity under article 2, paragraph 1, of the French Tax Code. CGI Israeli.
Arbiv's property income will also include rental income from properties registered in his children's names.
A note has also been sent to the "acquisition tax department", as the fact of having put the apartments in the children's names has significantly reduced Arbiv's tax charge on the various acquisitions.
If you have several apartments in Israel for long-term rental, you need to check whether you should be subject to "commercial" taxation.
If you have several apartments for rent in Israel, we strongly recommend that you carry out a full audit of your real estate assets, their profitability and the tax provisions to be respected.
This will enable you to find solutions for optimizing your wealth in Israel while respecting the legality of the Israeli tax system.
Dray & Dray can help you optimize your investments in Israel from a tax point of view.
Your questions - our advice
- Are you entitled to Mas rehisha - acquisition tax according to the "residential" bracket or do you have to opt for the "commercial" acquisition tax?
- Is there a risk of being requalified as a 'property trader in Israel'? What are the risks and how long is it advisable to wait before selling an apartment in Israel?
- Does the fact of having several apartments in Israel that are not all rented change the situation (under construction, loaned to relatives, etc.)?
- What about VAT and social security contributions if your property income activity is reclassified as a commercial activity?
- Does using a property manager "who takes care of everything" reduce the risk of requalification as a commercial activity?
- Do parents who have bought apartments in their children's names while retaining usufruct have reason to worry? Is there such a thing as an irrevocable gift in Israel? The Israeli tax authorities are taking a serious look at this type of transaction. Reforms are underway, so take our advice.