The California gold rush of 1848 to 1855 attracted people from all over America.
Now a new rush is under way to find United States real estate at
bargain-basement prices, and it is attracting Israelis and many others. If you
are one of them, make sure it’s all on solid foundations – physically, fiscally
and legally speaking.
Israeli investors in US real estate will want to
minimize taxes in each country. The US IRS wants tax on their US real estate.
The Israel Tax Authority wants tax from Israeli residents unless they are new
immigrants.
Therefore you need to plan with tax advisers in each country
various aspects, including:
• Entities: company, partnership, trust, REIT
•
Transactions: long-term investing, short-term flipping, development projects,
etc.
• Finance: local or international
• Avoiding double taxation: credit
for federal and state US taxes against Israeli tax in the right tax year
•
Repatriating income
• Exit strategy.
Israel’s tax treaty with the US
helps, but only partly. Consider not only income tax but also state and local
taxes, stamp taxes, estate taxes and so forth.
Tax rates US federal tax
rates typically range up to 35 percent, and dividends paid to Israeli
shareholders with at least 10% are generally taxed at 25% in the US according to
the USIsrael tax treaty. As for capital gains, the US federal long-term rate is
currently 15%, and there is a withholding- tax mechanism in FIRPTA (Foreign
Investment in Real Property Tax Act to help non-US persons pay the
tax.
In Israel, foreign passive (non-business) rental income is generally
taxable at rates ranging from 30%- 48% after deducting permissible expenses and
depreciation at Israeli rates (2%-4% of the building element, not land), less a
credit for US federal and state taxes, not city taxes. Alternatively, it is
possible to elect to pay 15% Israeli tax of the gross rent after depreciation at
Israeli rates, ignoring expenses and US taxes.
It seems you can chop and
change from year to year and perhaps even from property to
property.
Capital gains are taxed at various rates – typically 25% for
properties bought in 2012 on, or 20%-48% for earlier purchases. The Israeli tax
calculations are done in shekels and adjusted for Israeli
inflation.
National Insurance Institute (social security) obligations are
also payable in certain circumstances at various rates – but not on dividends,
capital gains or rent taxed at 15% in Israel.
Business operations may be
taxed at higher rates; e.g., development for onward sale, frequent
sales.
In practice, combined US-Israeli tax calculations should be
prepared on a case-by-case basis because the result can vary according to many
factors: the amounts, the location, losses, foreign tax-credit rules, whether
you are in the real-estate business, etc.
Is an LLC right for you? A
Limited Liability Company (LLC) is much talked about, but be
careful.
They can reduce tax layers for Americans living in America and
increase taxes for Israeli residents.
For US tax purposes, an LLC is
usually a transparent “flow through,” meaning the members (shareholders) are
taxed, not the LLC itself.
In Israel, the ITA has published a circular
allowing Israeli taxpayers to elect flow-through treatment in the first relevant
tax return. This means reporting the LLC income as your own that year and every
year and crediting US federal and state tax thereon. If you don’t elect
flow-through treatment in that first relevant year, you will generally pay tax
on distributions by the LLC-like dividends: 30% in 2012, if you hold 10% or more
of the LLC; 25% Israeli tax otherwise, with NO credit for US taxes (the tax
rates were 25% and 20% in 2011 and before 2012).
Therefore, the combined
US-Israeli tax rates on LLC income and gains can be quite high for Israeli
resident investors: 55%- 60% in total sometimes. So look before you leap into an
LLC. This also applies to US olim living in Israel. Other structures are usually
more tax efficient for Israeli investors.
What else should you watch out
for? Personal investment and LLCs offer no protection against US estate tax;
currently US federal estate-tax rates range up to 35%, but they may range up to
55% in 2013 under current legislation. In New York and elsewhere there is also
state estate tax. Non-US persons are exposed to US estate tax if they move into
the next world holding US assets worth $60,000 – a lot less than the minimum
threshold for US persons. Other structures such as regular corporations (not
LLCs) may afford more protection from estate tax. Or consider life
insurance.
If you use an Israeli or offshore corporation to hold US real
estate, check out the complicated US branch remittance tax (levied instead of
dividend withholding tax). The rate may be 12.5% under the Israel-US tax treaty,
or up to 30% otherwise.
In addition, check you financing arrangements.
Interest paid by Israeli residents to a US bank, savings institution, insurance
company or the like is liable to 10% Israeli withholding tax under the US-Israel
tax treaty. The treaty rate is 17.5% for interest paid to other US lenders.
Without the treaty, the usual Israeli withholding tax rate is 25%. If you don’t
withhold the tax, the interest expense isn’t deductible in Israel. If you do
withhold the tax, the US lender may not be able to fully credit the Israeli tax
and want to “be made good for it,” which means grossing up the
amounts.
Obtain a cash-flow forecast and check that you can repay the
finance. In a recent case, an LLC investor was committed to using all LLC profit
distributions to repay bank finance, without regard to Israeli (or US) taxes
also payable.
Ouch. Always have the LLC itself repay loans, not the
members.
Israeli investors in an LLC or partnership will typically
receive a US tax form K1 showing their share of profits for US tax
purposes.
This is usually not detailed enough for Israeli tax purposes;
for example, the asset cost and depreciation figures to calculate depreciation
at Israeli rates, which are different from US rates. And prepaid rental income
is immediately taxable in Israel; so are capital gains from “installment sales”
(property is sold, but the consideration is received in installments over time).
Israeli investors need to agree to additional information availability and to be
consulted where possible.
To sum up Always do your homework before
investing in real estate in the US (or anywhere else). The above summarizes just
a few of the many aspects that may need to be considered.
As always,
consult experienced tax advisers in each country at an early stage in specific
cases.
leon@hcat.co Leon Harris is a certified public accountant and tax
specialist at Harris Consulting & Tax Ltd.
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