The requirement of paying taxes on rent in the United States is a rather complicated topic that could be slightly hard to understand for us, as Israelis. That is why the following article is dedicated to reviewing the real estate taxing topic in the United States, the income from rent payments, and the method of calculation.
Tax payments on apartment rent in the United States – a complex topic
Tax payment on rent in the United States is not a simple topic and it can be quite challenging to understand. This is since there are many factors that come into play when setting the amount of taxes to be paid for the income from renting out a property in the United States.
In the following paragraphs we will discuss in length the reason for the existence of tax requirements on rent, the American federal tax brackets, and the tax rates that Israelis with income from rent in the United States are required to pay here in Israel as well.
Why is there a tax requirement on apartment rent in the United States?
The federal government in the United States imposes taxes on selling real estate properties and renting profit yielding real estate in the United States, called capital gains tax. it’s important to mention that capital gains tax is imposed on all profit made from selling property – also in the cases where it’s not real estate property.
What factors decide the tax rates on apartment rent in the United States?
The tax rate on selling real estate or on rent in the United States is based in the length of time that the property is owned by you seller / landlord and whether the location of the property is the main residence of the owner for 2 out of 5 years prior to selling / renting.
Does the tax on rent in the United States get paid to Israel or the United States?
Many Israelis have ownership of profit yielding properties in the United States that generate income from rent for them. In that case the question is posed: to which country is the tax paid for that income?
The answer to this question is provided in the tax treaty between the United States and Israel, which states that the first rights on tax collection is given to the country where the income is generated.
The meaning of this in the case discussed here is that rent received from the renting of real estate property in the United States, will be taxed firstly by the United States and only after that by the state of Israel.
First tax right versus residual tax rights when collecting taxes on rent in the United States
The right to tax first on income generated in a certain country is called “first tax rights”. In the particular case of American real estate investments, the first tax right would naturally go to the United States, while Israel would receive “residual tax rights”.
The meaning of this is that if there are differences between the tax collected on rent income in Israel to the tax collected in the United States, which makes the tax rate on rent in Israel higher, that means the property owner must first pay the tax they owe from renting out a property to the IRS in full, and only after that, the rest of the tax to the Israeli tax authority.
What is the tax rate on passive income in the United States?
The tax on renting out an apartment in the United States and in general, counts as passive income. This is why it’s important to understand what the tax rate collected on passive income is in the United States. The rate is a yearly and set tax rate of 30 percent. Since we’re talking about a very high tax, many Israelis right wonder, how can that amount be lower using tax planning?
Is there a way to lower the amount of tax owed on apartment rent in the United States?
Israelis who wish to lower the amount of tax owed on renting out an apartment in the United States, can do so by handing in a tax return to the IRS, and report on income from renting their property in the United States as income for a business or commerce in the United States (ECI: Effectively Connected Income).
The reporting of rent money as business income creates the option to offset from the income different expenses that could be considered a part of its production. In this case, the owner of the property in the United States will be required to pay taxes on the rent in the United States in the federal level, the state level, and the city level.
Taxes on rent in the United States and the federal tax rate
The federal tax rate in the United States is decided on in a progressive way (ranked) according to the amount of income and the familial status of the tax – payer: single, owner of the household, married couple who report on their taxes together, or couple who report on their taxes separately.
Federal tax brackets in the United States
Here is an example of the federal tax brackets in the United States for income from rent and capital gains for single people:
| Taxed portion of the rent | Tax owed |
| Up to 9875$ | 10 percent |
| Above 9875$ and up to 40,125$ | 12 percent of the marginal amount above 9875$ |
| Above 40,125$ and up to 85,525$ | 22 percent of the marginal amount above 40,125$ |
| Above 85,525$ and up to 163,300$ | 24 percent of the marginal amount above 85,525$ |
| Above 163,300$ and up to 207,350$ | 32 percent of the marginal amount above 163,300$ |
| Above 207,350$ and up to 518,400 $ | 35 percent of the marginal amount above 207,350$ |
| Above 518,400 $ | 37 percent |
Taxes on rent in the United States and the state tax rate
In addition to the federal tax paid on income from rent in the United States, in some case another tax of this kind is required to be paid, according to a tax rate defined in the specific state in the United States where the property is being rented.
This tax is called a state tax and it moved between 0 to 12 percent. This tax could alternatively be collected on a county level as city tax, and change according to the county the property is located.
After the tax – payer pays the American tax authorities the full amount for their income from rent in the United States, they must report on the earnings from rent in the United States in Israel as well and pay income tax on it.
Taxation in Israel for income from rent in the United States (and the world in general)
Article 122 A in the income tax order states that a tax – payer registered as an Israeli citizen is allowed to choose a taxing plan according to their preference between 2 taxing plans on rent in the United States:
- Tax on rent in the United States in the gross plan – this plan pulls a set tax bracket at the rate of 15% on the tax – payers’ gross income. Choosing this plan allows the tax – payer to deduct only depreciation expenses from what they owe in income, with no option to deduct the tax paid in the United States.
- Tax on rent in the United States in the net plan – this plan allows the tax – payer to enjoy tax deductions of all expenses related to maintaining the property in the United States, and pay only for the net income from the rent in the United States. This, while they get tax credit for property taxes paid in the United States, for the federal tax as well as the state tax. In this plan the tax – payers’ income will be taxed at their marginal tax rate, which would be no lower than 31%.
Needless to say, the tax – payer can pick their preferred tax plan every year, without being restricted on how many times they can switch between the two.
The bottom line
As you have probably understood if you’ve made it this far, real estate taxes in the United States are a complicated topic that isn’t completed when you’ve settled up with the IRS alone. Real estate investment in the United States actually involve aspects of Israeli taxation, which makes handling the tax on rent in the United States into a confusing and complex topic like no other.
That is why it is important to use the services of a company consulting on American tax, like MasAmerica, who employs experts on American taxation who are knowledgeable on American as well as Israeli tax laws.
We would be happy to create a meticulous tax plan for you, in order to lower the amount of taxes you owe in the United States and in Israel to the lowest possible amount. Contact us for details!
