Investing in U.S, whether it is commercial real estate or residential real estate, requires tax reporting to both the Israeli tax authorities and the U.S. tax authorities. However, it that doesn’t imply that the investor needs to pay double tax on the same income: United States and Israel have a tax treaty to regulate income taxes and protect its citizens against double taxation. In accordance with the Convention, the U.S has the first bite to tax on US real estate investment, and the tax paid in the US will be claimed as a tax credit against Israeli taxes subject to imitations.
Income related to real estate investment in the U.S. arise from the following two sources:
- Rental income, and
- Capital gain on the sale of the property.
2. Israeli Tax Reporting
As noted, rental income from real estate property in a foreign country requires reporting to the Israeli tax authorities as follows:
Opening tax file with the Israeli tax authorities- Paying estimates: Upon opening a tax file with the Israeli tax authorities.
- File an annual tax return.
There are 2 options for reporting taxes in Israel:
Filing an annual tax return: it is highly recommended to use a CPA that has special expertise in the field.
- Short form reporting: no annual report is necessary, but every two months the taxpayer needs to send 15% of the gross rents with a voucher at the post office. There is also some interaction with the tax authority assessor (receiving some documents, etc.)
3. Israel Tax System
An Israeli resident who has rental income can choose one of these 2 options:
Tax payment resulting from the net profit based on the marginal tax rate of the taxpayer (profit is "income minus expenses" starting at 30%) while providing credits of the US Tax paid.
In this option, there may also be payments to the National Insurance Institute, at a rate of 12% unless this income is treated as passive which became recently exempt.
- Flat 15% tax option: Tax Payment of a flat 15% rate on the total rental income less Israeli depreciation.
Under this option, the investor can’t offset expenses nor a tax credit for the taxes paid in the United States.
The followings are some important Tax Considerations:
- The reduced tax rate applies only to rental income not considered as business income in Israel. If there is income from the business, the relevant option is the “marginal tax”.
- There are additional issues to take into consideration regarding purchasing a property through LLC, as for Israeli tax purposes, LLC is considered a company. It’s advisable to consult with an Israeli accountant for LLC’s taxation in Israel.
- Options can be switched over the years, and it’s worthwhile to check on a yearly basis what is the preferable option.
- Israeli tax system is basically very similar to the American one, but there are certain difference between both countries such as different depreciation rates, exemptions based on low income….
Sale of the asset:
The tax rate in Israel on capital gains is 25%on foreign properties and he can benefit from U.S. tax credits.
We emphasize that in general, the Israeli tax authorities may even challenge some of the above reports in general, and since US real estate investments becomes more common, regional assessors gain more experience handling reports that include property in the United States.
4. Common issues
a. Is there an obligation to report tax even for Capital losses?
Concerning the investors who would not have to report if they did not had the investment in the US, a report needs to be filed in Israel only if any of the following applies:
- The taxpayer holds 10% or more of corporate shares - LLC is considered a corporation in Israel.
- The same taxpayer derives income from the corporation – "income" refers to turnover and not to gain or capital loss.
- The investment attributable to the taxpayer exceeds a certain amount.
- The Tax assessor evaluated that he needs to report tax.
- In consequence, if the taxpayer holds less than 10% of LLC shares or directly in the property and the property has not yet generate any income (for example, land holdings), he doesn’t have probably to file a return.
b. Report on investment that did not generate yet income - is there an obligation to fill out Form 150?
Form 150 (Declaration of Holding in Foreign corporations) is a form intended for taxpayers who must already report taxes according to the above criterias. In other words, if the taxpayer does not have to file an annual return, then he does not have to fill out this form.
c. In the event that the taxpayer invests in LLC about 25% of the required capital and the balance of the investment is through foreign financing, if he incurred a loss in the first years, should he choose a "marginal tax" track?
As noted, it is possible to "split" between a marginal tax and a flat 15%. Since only the marginal tax has the option to accumulate and transfer losses from year to year, it’s advisable to choose that option in the earlier years.
d. Is accelerated depreciation applicable?
The depreciation rate in Israel is between 2% and 4% depending on the type of asset, while the depreciation rate in accordance with US law may differ.
e. Are renovations tax deductible in Israel?
The answer is similar to the one of depreciation. Under Israeli Law, renovations are not always considered an expense, but in some specific cases they could be capitalized and added to the cost of the property, and he can deduct the expense through depreciation over the years.
f. Exempt income, is it applicable in Israel?
According to US law, capital gain is exempt up an annual threshold. However, in Israel, such exemption is not applicable.
g. Sale of the asset – can it be offset against capital gain losses? What's the tax rate? How depreciation affects capital gains?
- Capital gain from the sale of the property is subject to a tax rate of 25% in Israel and he can benefit from foreign tax credits.
- Capital losses generated from the same asset and haven’t yet been offset, can be offset.
- Depreciation recorded over the years until the sale of the asset has a direct impact on capital against reduces the adjusted basis of the property, therefore increases the taxable capital gain.