The income tax in Israel is not among the lowest, and while the tax from income from your job can reach 50%, the government allows real estate owners to choose one of three tax routes that will enable low tax rates on rental income, regardless of the income from your work or business, encouraging them to rent out their properties.
Here are the routes for residential rental:
1. The tax-exempt route (full or partial)
2. A reduced tax at a fixed rate of 10%
3. Billing according to tax brackets
1. Tax-exempt Route
The Income Tax establishes a number of cumulative conditions for granting a tax exemption on income from residential rent in Israel:
a. The property is rented to individuals for residence (and not any kind of business)
b. The property landlord has a written contract with the individual stating the first condition.
c. The monthly income from all the apartments rented by the landlord (including his spouse who lives with him or his children up to the age of eighteen) does not exceed the set exemption.
As of 2021, the exemption ceiling is 5,070 NIS. This amount is updated every year.
d. If the sum of the monthly income exceeds the exemption ceiling but is less than twice the amount of the ceiling (10,140 NIS), the balance of the exemption will be reduced by 1 shekel for each shekel exceeding the ceiling. This portion (adjusted ceiling) will be subject to a marginal tax rate.
A. Monthly rental income is 4,500 NIS.
Since the exemption ceiling is higher, the landlord won’t pay any taxes.
B. Monthly rental income is 8,000 NIS.
The sum exceeds the ceiling by 2,930 NIS (8000 – 5070 = 2930).
We deduct that amount from the ceiling to get the adjusted ceiling (5070 – 2930 = 2140).
The adjusted ceiling is 2,140 NIS
*For easier calculation, we can reduce the rental sum from double the ceiling:
10140 – 8000 = 2,140
New taxable sum is 5,860 NIS (8000 – 2140 = 5860).
Against the taxable part in those cases where there is a partial exemption, it is possible to offset a proportionate part of current expenses incurred by the landlord in connection with the rental of the apartment (lawyer’s fees, management fees, broker fees, etc.)
2. Reduced Tax at a Fixed Rate
This is a route with a fixed 10% rate. The route will apply under the following conditions:
a. The apartment is used for residence
b. income from rent is not considered as business income. Keep in mind that Income Tax Authority can decide that starting from a certain number of apartments, the rental will be considered as business.
For example, if the monthly rental income is 15,000 NIS, then the landlord will pay 1,500 NIS tax (10%).
This route doesn’t allow deducting ongoing expenses incurred by the landlord in connection with the rental of the property (repairs, attorney’s fees, management fees, etc.).
3. Billing According to Tax Brackets
In this route, the landlord’s marginal tax rate will be determined according to his total income. This route allows deducting all ongoing expenses connected to the rental.
Regarding rental income, the first tax bracket is 31%, with the exception of a landlord who has turned sixty in the tax year, for whom the first tax bracket is 10%.
It should be noted that choosing this route requires the submission of an annual report to the income tax authority.
Business vs. Passive Income
For the rental of residential apartments in Israel that come to a business, tax rates that apply to income from a business will apply, and it will not be possible to enjoy the tax benefits in the exemption route and in the reduced tax route as stated above.
There are a number of tests for determining whether it is passive income or whether it is active income that goes to a business. According to the Tax Authority, renting more than 10 apartments provides a significant indication of the existence of a business; income from renting less than 5 apartments will be considered passive income that does not reach a business, and for renting more than 5 apartments but less than ten will consider additional tests to determine the classification of income from rent.
The choice of taxation route can be changed for each tax year separately, and it usually depends on the amount that comes from renting the properties. One property owner will usually be able to enjoy the exemption route.
We recommend seeking professional advice to calculate the best tax route for you. If you are looking for tax advisors or you are interested in investing and property management, don’t hesitate to get in touch with us and start making the most out of your shekels.
This article originally appeared on Buy Home in Israel and is reposted with permission.