Does the instability in the stock market lead you to search for a safer and more stable investment channel? Like many others, you probably think that real estate investments are a safe and stable investment channel. And so, investing in real estate is a common practice both in Israel and abroad. Furthermore, with the expected decline in home prices due to the coronavirus crisis, the real estate market will become an especially lucrative investment channel – a minimal investment that will yield high profits. So, if you are also considering investing in American real estate, you should consider the tax aspects of such a transaction – these aspects are critical to ensure the viability of the transaction.
In an attempt to provide you with a general idea of the aspects to consider when investing in real estate, we have prepared the following guide before you. Naturally, this is just an overview, and we strongly recommend consulting with a professional and to conduct rigorous tax research before any investment.
Renting residential apartments in the United States – key aspects of the American taxation system
First of all, it is important to remember that when investing in American real estate several layers of taxation will apply: the federal layer, the state layer, and the municipal layer. For the sake of simplicity of this discussion, we will deal with the central layer – taxation at the federal level, but we emphasize that this layer will come along with various additional tax liabilities, under the state and municipal area where the investment property is within. In addition, there are additional taxes that are not included in the review here and which may be relevant when deciding how profitable a certain investment might be (such as estate tax and snooping tax), these must also be considered.
When talking about federal taxation, how the investment is made is significant: a direct investment, an investment through an American corporation, or an investment through a foreign company.
Direct investment
An investment made by a private individual.
In the case of an American citizen who invests in a property, provided that the income thresholds set by law are met, he will be required to report this income, together with his global income, as part of the annual income tax report (Form 1040). The income will be taxed according to the marginal tax rate applicable to it – a rate ranging from 10-37%, which depends on the income rate of the individual.
In the case of a foreign citizen, provided that the income thresholds set by law are met, it will be required to report this income, along with the rest of its income originating in the United States, as part of the annual income tax return (Form 1040NR). Income from rent earned by foreign investors is usually classified as FDAP income (Fixed, Determinable Annual or Periodical), which is taxed at a rate of 30%, without the option of deducting expenses from the amount.
Sometimes, as part of tax planning, by classifying income as income from a business it is possible to reduce the tax rate to marginal tax rates that apply to an individual according to the level of income, as well as deducting expenses from that amount.
Investment through a U.S. corporation
This is an indirect form of investment when there are several possible forms of incorporation. We will address the main incorporations: L.L.C and C-CORP.
A company (C-CORP) is a separate legal entity from its owners who enjoy limited liability which means the liability is limited to the amount of their investment. A company is also obligated to file an annual tax report and reporting its income, including income from renting. Such income is under a corporate tax rate of 21%.
A partnership (L.L.C) is a limited liability legal entity, whose uniqueness is that it is transparent for tax purposes. This means that the owners of the partnership are liable for its tax, based on the tax regime applicable to them.
If the owner is a company – then according to the corporate tax rate. If the owner is a private individual– then according to the marginal tax rate that applies to him. It is estimated that there may be tax benefits that specifically relate to income from a business, based on the partners’ income.
Investment through a foreign company
As in the case of investing using an American company, a foreign company is a separate legal entity with limited liability. The foreign company must report its annual income tax and its various income channels such as income from renting properties. Such income will also be taxed according to corporate tax rates.
Renting residential apartments in the United States – aspects of Israeli taxation
So far we have reviewed the aspects of taxation in countries – aspects that depend on the nature of the entity that holds the property. However, an equally important aspect for Israeli investors is what will be the tax liability for this income in Israel.
An Israeli citizen investing in the United States is required to pay tax both in the country where the income was generated – the United States for example and in Israel. The tax will first be paid in the United States, and then in Israel. When paying tax in Israel, the taxpayer will be entitled to a credit due to “foreign taxes”. However, in Israel as well, the manner in which the investment was made is important:
Direct investment
The taxpayer may choose between two taxation tracks:
Marginal tax rate
The income will be taxed at the marginal tax rate according to the taxpayer’s income. In this track, the taxpayer will be able to offset expenses and receive a tax credit for foreign taxes.
Fixed tax rate
The income will be taxed at a rate of 15%, without a possibility to offset expenses or receive tax credits for foreign taxes.
Investment through an American or Israeli company
Corporation revenues will be subject to corporate tax, as well as dividend tax on shareholders when distributing profits.
Investment through L.L.C
As mentioned above, n the United States L.L.C. companies are transparent for tax purposes, and it is the owners who bear as individuals the tax liability. However, Israel does not recognize the above association, and as for the taxation aspect, the L.L.C is treated as a company and a corporate tax rate is imposed on any income and a dividend tax on the distribution of profits.
For many years there the matter was unclear. In recent years, a number of verdicts have been issued in the matter. Based on these verdicts it is clear that the tax rate will depend on the way the taxpayer chooses to classify the company. To the extent that the company is not transparent for tax purposes in Israel, then only a dividend tax will be levied on the distribution of profits, without it being possible to obtain a foreign tax credit.
To the extent that the company is transparent for tax purposes in Israel, its revenues will be taxed according to corporate tax rates, but it will be possible to offset expenses and receive a credit on foreign tax. The distribution of profits will not be taxed.
Since there is still some lack of clarity about how L.L..C in Israel will be taxed, we will recommend seeking professional advice on the subject.
Renting a residential apartment in Israel – taxation aspects
In the case of renting a residential apartment in Israel, Israeli citizens (whether or not they have dual citizenship) will be liable to tax at a rate of 10% on income from rent income that exceeds 5,070 NIS. If the income from rent is made using a corporation, this income will be taxed at a rate of 25%.
However, in the case of citizens with American citizenship or alternatively American corporations, they will also be required to report in the United States, where they will be taxed according to their income or according to corporate tax rates. Due to the double taxation treaty, they will be able to receive credit for some of the amounts, all based on the provisions of the convention.
Closing words
As we all can clearly see, the tax aspects of international investment are extremely complex. Careful and professional tax planning is a necessary condition for ensuring the viability of your investment and minimizing tax liability. The MasAmerica team is knowledgeable about all the secrets of both American and Israeli tax provisions and will be happy to help you turn your investment into a success.
