Tax Payment on Income from Rent / Ohad Shpak
Before deciding to invest in residential property in Israel, considerations of the feasibility of the investment should be examined, including tax payments – both on rent and at the time of sale of the property in the future, in the form of capital gains tax.
Three main tax options on income from rent are possible:
(A) Tax exemption option (full or partial) – This option is limited to a maximum income from rent of NIS 5,010 per month from residential property, as long the property is being rented to individuals1.
When the amount of monthly income from rent is higher than NIS 5,010 for 2017 but does not exceed NIS 10,060, the taxable amount must be calculated according to the Tax Authority formula, and a marginal tax rate will be applied, taking into account the landlord’s total income.
For income from rent, the first tax bracket is 31%, except for individuals who have the age of 60 in that tax year, for whom the first tax bracket is 10%.
It should be noted that the landlord is entitled to deduct current expenses related to the production of income from rent, such as legal expenses, current repairs and depreciation at a rate of 2% of the cost of purchasing the rented property (not including cost of land).
On the other hand, in the full or partial exemption option, the landlord is not entitled to deduct depreciation (a certain percentage of the apartment’s value) from the income obtained from renting the property, and not only, when they sell the property, the depreciation value will be deducted from the value of the purchase, which will thereby increase capital gains tax liability.
In addition, the landlord is not entitled to deduct financing expenses and betterment expenses at the time of sale, and reduce capital gains tax liability, since the exemption on this option covers current expenses.
(B) An option for 10% reduced tax rate – This option can be chosen when the property is used for residential purposes in Israel, and rental income is not considered income from a business under the Israeli Income Tax Ordinance.
When choosing this option, the landlord is not entitled to deduct expenses incurred in producing income from rent or depreciation, but only current expenses, such as repairs and current depreciation.
At the time of the sale of the property, the potential depreciation value that would have been deductible, had it not been for the choice of this option, is deducted from the purchase value of the property, thereby increasing capital gains tax liability. In addition, the landlord is not entitled to deduct financing expenses and betterment expenses at the time of sale, and reduce capital gains tax liability, since the reduced tax in this option covers current expenses.
(C) The full tax option – tax owed according to tax brackets – In this option, the landlord is liable for a marginal tax rate, taking into account their total income.
I will mention that for income from rent, the first tax bracket is 31%, except for those who have reached the age of 60 at that tax year, for whom the first tax bracket is 10%.
In this option, it is possible to deduct permitted expenses from the income (such as maintenance expenses, mortgage interest) and depreciation expenses. At the time of sale, the landlord or seller are not entitled to deduct current expenses and reduce capital gains tax liability, and the amount of depreciation deducted will be deducted from the purchase value, thereby increasing capital gains tax liability.
1 It is also possible to rent to a group, but only if most of the group’s activity is for the purpose of providing housing to eligible persons as determined by the Ministry of Construction and Housing, for immigrant absorption, for health and welfare, and for non-profit activities