Betterment Tax for foreign residents on the sale of an entitled residential apartment, in light of the reform in the Land Taxation Law
In my previous article I reviewed the recent major changes in the Land Taxation Law (Betterment and Purchase), 5723 – 1963 (hereinafter: the "Land Taxation Law"), regarding the purchase tax that will apply to foreign residents.
Significant and broad changes apply with regard to the grounds for exemption from the payment of betterment tax on the sale of a residential apartment, which is an entitled to a tax exemption. Some of the changes apply equally to Israeli residents and foreign residents, on the one hand (also on the purchase of an apartment) ; but on the other hand some of these changes also result in preferential treatment for individual sellers of an apartment in Israel over foreign residents. The changes in the Land Taxation Law with regard to the sale of an entitled residential apartment came into effect on January 1, 2014.
The purpose of this short article is to briefly clarify the key changes that have taken place in land taxation on the sale of residential apartments in Israel in respect of foreign residents.
- As mentioned above, a significant and broad change applies with regard to the grounds for exemption from the payment of betterment tax on the sale of an entitled residential apartment. We refer here to a change in concept in relation to the sellers of residential apartments in Israel and taxation on the investment in residential apartments.
In general , let it be stated that over the past few decades, apartment owners who own more than one residential apartment have been able to sell an apartment once every four years with exemption from betterment tax – without restriction in regard to the maximum number of apartments in their possession; without restriction in respect of the sum of the sale; and with no distinction between Israelis and foreign residents – except that the residential apartment being sold is to be an entitled residential apartment as defined in the Land Taxation Law.
- The instability in the stock markets, low interest rates which resulted in lower interest rates on mortgages, and tax exemption on the sale of an apartment, caused many private investors in Israel – who were looking for the best investment for their money after the financial crisis in 2008 – to invest in residential apartments as an economic channel by which to earn yield on their money. At the same time, rising real estate prices combined with exemptions from payment of betterment tax on the sale of residential apartments in Israel, every four years – regardless of the issue of residency – has made the investment channel of residential apartments in Israel worthwhile for foreign residents.There is no doubt that in Israel after 2008 a winning investment channel was created for Israeli residents and foreign residents: the purchase of apartments the prices of which had been on the increase from 2006 and a handsome profit from the exemption from betterment tax in Israel on the sale of the apartment; and often also a handsome return in the form of annual rental fees.
- Many economists are convinced that the influx of investors wishing to purchase residential apartments – in this or any other constellation – was part of the totality of causes that led to an increase in prices, leading to even greater attractiveness of this channel – on the one hand – and to the creation of a ‘bubble’ on the other hand. In addition, the involvement of foreign residents in investment through the purchase of residential apartments in Israel was also part of the overall reason for the distortion in the prices of apartments.
- Against the background of the aforesaid, inter alia, and the desire of the State to collect more taxes, of course, it was decided as part of the most recent reform in the Land Taxation Law that the grounds for exemption on the sale of a residential apartment once every four years Article 49b (1) – which had been the central and classic grounds for receiving an exemption for the sale of a residential apartment –should be canceled as from 1.1.2014 , both in respect of residents of Israel and with respect to foreign residents (see instructions for executing Land Taxation 5/2013).
- From now on, anyone who owns more than one residential apartment at the determined date – i.e. 1.1.2014 – will be considered as owning multiple apartments and, in principle, will be liable for the payment of betterment tax on the sale of his apartments subject to the provisions of the Land Taxation Law.
- In addition, the grounds for exemption in the sale of a single residential apartment once every eighteen months in accordance with the Land Taxation Law shall not be cancelled – however, a further condition has been added and that is the condition of actual ownership by the seller (either by himself of whether by means of a tenant) for a period of eighteen months from the date that he became the owner of the right to it ; and on the assumption that this does not refer to the sale of a residential apartment that was received as a gift; in which case it is possible that an additional period will be required in addition to the actual holding period, of an additional ‘cooling-off’ period from the date that the apartment was received as a gift.
In addition, as part of the reform, a definition with regard to the sale has been established in respect of the fifth Chapter 1 of the Land Taxation Law whereby only an Israeli resident or a foreign resident who does not own a residential apartment in the country in which he resides is entitled to benefit from exemption in accordance with this section. Moreover, the sum of the sale exempt from taxation is now limited. That is to say: in principle and subject to the provisions of the Land Taxation Law, from now on exemptions will be given from the payment of betterment tax only to anyone selling the only residential apartment that they own, on the condition that it was owned (whether by himself or whether it was leased) for a period of at least 18 months, and on the condition that he is an Israeli resident (or a foreign resident that does not own a residential apartment in the country in which he resides).
- In respect of foreign residents who do not own a residential apartment in the country in which they are residents, official confirmation is required on behalf of the country of residence regarding such status, in order to obtain the exemption; however, it is not certain that the country of residence does, in fact, issue such confirmations and that such confirmation may be obtained.
- Moreover, the sum of the sale exempt from taxation as aforesaid is limited (NIS 4,500,000) and the remainder will be debited with betterment tax in accordance with the new linear method (details below).
Part B – the sale of an inherited apartment
- Additional grounds for receiving exemptions from the payment of betterment taxation on the sale of a residential apartment relate to the exemption on the sale of an inherited apartment in accordance with Article 49b (5) Betterment Taxation Law.
The Article says:
" The sale is of an entitled residential apartment that the seller received as an inheritance, provided that the following conditions are fulfilled:
- the seller is the spouse of the testator, or the offspring of the testator, or the spouse of the offspring of the testator;
- prior to his death, the testator owned only one residential apartment;
- if the testator were still to be amongst the living, and were to be selling the residential apartment , he would be exempt from taxation on the sale. “
[Land Taxation Law (Betterment and Purchase), 5723 – 1963, published in LawData]
In other words, the cumulative conditions are that the seller shall be one of the close relatives of the testator as aforesaid in subsection (a); prior to his death, the testator was the owner of only one residential apartment and if the testator would have sold it he would have been entitled to a tax exemption on the sale.
We will examine how this affects foreign residents and their relatives;
Firstly, and especially when dealing with foreign residents, the question arises of whether the term "seller" is as defined in the definitions of the fifth Chapter 1 of the Land Taxation Law – an Israeli resident or a foreign resident who does not own a residential apartment in the country in which he is a resident. That is to say, if the term the ‘seller’ here is as this is defined in the aforesaid fifth Chapter 1, then the exemption on the sale of an inherited apartment will be granted only to Israeli residents or foreign residents who do not own a residential apartment in their country of residence. Otherwise – and for the purposes of exemption on the sale of an apartment that he received by inheritance – a seller is any seller whatsoever, and not necessarily in accordance with the definition of “seller” as stated in the fifth Chapter (1) of the Law; in such instance the question of residency is irrelevant in terms of the identity of the seller.
We can understand what is involved:
In one instance the testator is a resident of Israel and is the owner of one residential apartment , and he bequeathed his apartment to his child – a foreign resident who owns an apartment in his country of residence. In this instance, although seemingly the testator complies with the conditions of the clause, the seller – the recipient of the inheritance – shall not be entitled to an exemption because he (the seller) is a foreign resident who owns an apartment in his country of residence and therefore will not be entitled to sell the apartment with this exemption.
Another instance is an instance in which the testator is a foreign resident who owns an apartment in his country of residence. In addition, the testator had one apartment in Israel prior to his death and he bequeathed it to his child who is a resident of Israel. Inthis case the inheritor is a relative of the testator and the testator did, in fact, own one residential apartment on the eve of his death; however, if he would have sold it at the present time he would not be entitled to an exemption for the sale and therefore, it is not possible to take advantage of this exemption and the seller will be required to take advantage of his own personal exemption if it is his only apartment.
Moreover, the reform in the Land Taxation Law also determined in the law of owning a single apartment – Article 49 C of the Law, which says the following:
"For the purposes of Article 49b (2), the apartment being sold shall be deemed as the only residential apartment unit owned by the seller even if he has, in addition to the apartment being sold, another residential apartment to which any of the following apply:
- It was purchased as a replacement for the sold apartment during the 18 months preceding the sale;
- It was leased as protected rental housing prior to the date 22nd of Tevet 5757 (January 1, 1997);
- The seller’s share in the ownership is not more than one-third.
- It is an apartment that was received through inheritance and the conditions of clause 49b(5) (a) and (b) apply thereto.
(Land Taxation Law (Betterment and Purchase), 5723 – 1963.published in LawData)
That is to say, a situation in which the seller owns one residential apartment and he receives an apartment through inheritance from the testator who owned several apartments – then receiving the apartment through inheritance will prevent him from also selling his apartment with an exemption from betterment tax as it would be considered as multiple residential apartments in accordance with this definition; and also the sale of the inheritance apartment will be taxed at the time of sale. This is true both for foreign residents and for Israeli residents.
It is clarified and emphasized that there are additional grounds in the Land Taxation Law for exemption from payment of betterment tax on the sale of a residential apartment, but this article does not deal with them and / or their applicability to foreign residents.
- Nevertheless, the tax will be imposed only on the actual betterment (gain) generated after 1.1.2014 as the taxation imposed on betterment generated prior to 1.1.2014 is retroactive taxation, which is prohibited. Calculation of betterment will be the new linear method. In addition, and in order to prevent flooding the housing market, a transition period has been determined between 1.1.2014 to 01.01.2018 during which it was decided that the linear taxation, and relative to the period that began from 1.1.2014, will only apply to the sale of two apartments in the period between 1.1.2014 to 01.01.2018. In other words, anyone who owns more than one residential apartment on that date (1.1.2014) and will be interested in selling them during the aforesaid transition period, would be able to sell only two of them during the transition period, and then the tax calculation will be the new linear method and will relate only to the period from 1.1.2014, whereas on the sale of additional apartments beyond the first two residential apartments during the transitional period a tax will apply on all the betterment that was generated from the date of acquisition (and not from 1.1.2014) and the calculation will be a normal calculation (imposition of betterment tax for the entire period) and not by the new linear method.
An example of calculation in accordance with the new linear method:
Eitan owns several apartments and is considered to be a multiple-apartment owner; he wishes to sell his apartment on Dizengoff Street in Tel Aviv. The apartment was purchased by him on 1.1.2005 at a price of NIS 1,000,000 and he is selling it on 1.1.2015 at a price of NIS 2,000,000. The new linear calculation is done using the following method: the purchase price should be linked to the index until the date of sale. For example, suppose the adjusted purchase price as at 1.1.2015 is NIS 1,300,000, and we will also not take into account the permitted expenses deductible under Article 39 of the Law [betterment fees, purchase tax, legal fees, brokerage fees, investment in the property (subject the provisions of the Law), etc.]. That is to say, the betterment for the entire period is: NIS 2,000,000 less NIS 1,300,000 = NIS 700,000. The cumulative betterment is divided by the number of years the apartment was owned – 10 years, resulting in a sum of NIS 70,000 annual betterment. The annual betterment is multiplied by the number of taxable years of ownership commencing on 1.1.2014 ; in this case – only one year, and amounts to a sum of NIS 70,000. The resulting sum – NIS 70,000 – is the result of multiplying the number of years of annual betterment by the number of years of taxable ownership multiplied by 25% resulting in a sum of NIS 17,500, which is then the sum of betterment tax to be paid.
To better understand we will use that same example but this time the acquisition date will be 1.1.2006 and the date of sale will be 1.1.2016. Apart from that, the remaining data are identical. In this case we still attain a sum of NIS 70,000 in annual betterment tax, but this time the number of taxable years commencing on 1.1.2014 is two years and therefore the calculation will be 70,000 x 2 x 25% = NIS 35,000 as the sum of betterment tax to be paid.
To complete the picture, a reservation should be made and let us say that in the case of sale of an apartment that was rented, depreciation that could be deducted to the full extent should be taken into account, which affects the adjusted purchase price. Furthermore, let us add that in the case of an apartment being sold which was purchased prior to 1994 we must take into account the addition for payment of the tax for the inflationary betterment tax as specified in the Law. Moreover, we are referring to the sale of an apartment the payment for which is not affected by unused building rights.
- In the case of sale of an apartment for which the selling price is NIS 4.5 million and the seller is entitled to exemption of betterment tax for the sale, then as of 1.1.2014 the seller shall be entitled to exemption from betterment tax up to a ceiling of NIS 4.5 million; the balance will be liable for betterment tax in accordance with the new linear method and subject to the provisions of the Land Taxation Law.
- In conclusion, in this article we reviewed, in a nutshell, the changes that have taken place in the grounds for the main exemption in the sale of an entitled apartment by a foreign resident, and how it is possible to see the reform in the Land Taxation Law express the desire of the legislature and the State to make the investment in residential real estate in Israel a less worthwhile channel both for Israeli residents and also foreign residents as well as trying to encourage the sale of apartments on the part of multiple apartments owners and / or foreign residents during the transitional period (1.1.2014 through 1.1.2018) so that the sum of betterment tax payable in the "new linear method" will be lower, the closer the date of sale of the apartment will be to the date 01/01/2014 .
The foregoing does not constitute a legal opinion, nor does the above stated constitute a substitute for specific legal advice.
Copyright – Omer Rottenberg, Adv.
22 Ben Gurion Street, Herzliya 4678525
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