Triple trouble?

Questions and answers on taxes.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)
Q: We acquired a London home years ago and want to give or bequeath it to our grandson Harry, who is moving to Israel. The market value has risen considerably. His wife is a US citizen. Will the UK HMRC, the US IRS and the Israeli Tax Authority (ITA) fleece everyone? That would be triple trouble.
A: Dear Liz,
This question frequently occurs when family members are on the move. There is no need to be fleeced, but homework is necessary.
Israeli tax holiday
If Harry and his wife are immigrating to Israel or just taking up Israeli residence, they should enjoy a 10-year Israeli tax holiday (exemption) for non-Israeli income and gains. And the receipt of gifts or inheritances are not reportable to the ITA nor taxable in Israel. Special rules apply to trusts and frequent flyers between the two countries. So far, so good.
UK inheritance tax
The UK imposes inheritance tax (IHT) on death and on certain lifetime gifts. If Liz passes on a home upon death to her husband or civil partner, no UK IHT applies.
If Liz gifts the home to Harry “without reservation,” there’s normally no inheritance tax to pay if neither Liz nor Harry live there and Liz lives for another seven years.
If Liz wants to continue living in the property after giving it away (gift with reservation), then according to the HMRC website she’ll need to:
• pay rent to the new owner at the going rate;
• pay her share of the bills; and
• live there for at least 7 years.
If Liz dies within seven years after gifting the property to Harry, IHT is charged in the UK at 40% on gifts given in the three years before death. Normally the first £325,000 is exempt from IHT. If Liz gives away a home to her children or grandchildren this exemption can increase to £475,000 if Liz’s estate is worth less than £2 million.
Gifts made three to seven years before death are taxed on a sliding scale known as “taper relief.” The tax rate decreases by 8% per year, i.e. 32% if death occurs in the fourth year, 24% in the 5th year, 16% in the sixth year and 8% in the seventh year.
Capital gains on sale
Here the going gets tough. If Harry sells the home transferred from Liz, he may pay UK capital gains tax (CGT) of up to 28% on the sale price minus the value on the date of Liz’s gift or death, subject to any principal private residence relief.
In Israel, after the 10-year tax holiday, Israeli CGT typically ranges from 28%-50% but on the sale price minus your historic cost. There are several ways of mitigating this: Israeli CGT taper relief, a credit for UK CGT, or claiming discretionary relief to use the value on death or gifting (“step up election”) as the cost.
Harry will calculate the UK tax in sterling terms and the Israeli tax in shekels, adjusted for Israeli inflation, and even hyper-inflation in the 1970s and 1980s (e.g., NIS 100 in 1951 equates to NIS 34.4 million in 2020).
If the property was acquired pre-2003, the Israeli CGT rate can range up to 50%. Concessionary CGT rates apply if the property was acquired pre-1948 (i.e. under British rule!). All in all, the result is unpredictable, and the “step-up election” is sometimes better.
Rental income
Rental income is subject to UK tax, and Israeli tax after the 10-year tax holiday. Expenses are only allowable for UK tax purposes if Harry signs up to HMRC’s non-resident landlord scheme. In Israel, after the 10-year tax holiday, Harry can choose between: 1) 15% Israeli tax on the gross rental income less Israeli depreciation, or 2) regular Israeli tax on net rental income after deducting Israeli depreciation and expenses and crediting UK tax.
US citizen wife
As for Harry’s wife, US citizens are subject to US taxes on worldwide income wherever they live, even in Israel. There is a system of foreign tax credits to help avoid double taxation, and an exclusion for non-US earned income in certain circumstances. US advisers must be consulted in conjunction with advisers in all other countries concerned. In this case, consider whether Harry’s wife owns anything, such as the London property, in her own name.
Please contact us, Liz and Harry, for a more meaningful review.
As always, consult experienced tax advisers in each country at an early stage in specific cases. The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. [email protected]