'Third Property' Tax

Update - As of August 2017, this tax has been cancelled. Therefore, as of now, the below is no longer relevant.

The war that Finance Minister Moshe Kahlon has been waging on Israeli property prices has been well documented and shows no sign of abating. His newest weapons to date is the ‘Third Property’ Tax law, which was proposed in 2016 and was passed a few weeks ago in January 2017. There are still a number of legal hurdles to be overcome, however assuming that these are resolved, over 60,000 owners of three or more residential properties in Israel will be affected, not to mention the many more who may have been planning to become part of this targeted group. For this reason, we have a brief look below at the background to the new law and its ramifications.

Background

It has been very much assumed that a major driver of escalating residential property prices in Israel over recent years has been the activity of investors. With bank deposit rates close to zero, investors, both savvy and less so, would simply take their cash out of the bank and park it in an apartment somewhere in Israel. Indeed, even after the introduction of high purchase taxes in order to stem the flow, it can still be argued that certain aspects of the Israeli income tax regime are skewed in favor of owning real estate, as seen by the favorable tax treatment of rental income in comparison with, say, dividend income from the stock market.

The Finance Ministry further assumes that the third property owned is the one "for investment" (the first being the primary residence and the second perhaps for the kids). Therefore, it is targeting the third property owned, an onward. The goal of this law is simple – cause these investors to sell their investment properties by taxing them and reducing their already-low income yield to the point that the property is not worth holding on to. Lots of properties then hit the market causing prices to come down.

What is the Tax

Put simply (even though in practice it is anything but simple), for owners of more than 2.5 residential apartments in Israel, there will be a new annual tax, which is calculated as 1% of the lowest valued property, up to a cap of 18,000 Shekel per year. The value used for the calculation will not be the market value, rather the government will use a formula based broadly on the size of the apartment and the neighborhood it is located in.

What do the opponents say ?

The main argument put forward against the tax, including by leading figures in the Israeli economy, is that rather than flood the market with properties and cause prices to come down, landlords will simply roll the new tax on to tenants and thus cause rent levels to increase. To counter this, when the law passed it was made it illegal for landlords to do this.

The other argument was that the law included an in-built distortion whereby a wealthy landlord owning, say, two 12m Shekel apartments in Tel Aviv would pay no tax, whereas someone who owned 3 apartments worth 700,000 Shekel each would have tax to pay. Furthermore, a landlord who owned three properties each worth 2m Shekel would be hit with the full 18,000 Shekel a year (1% X 2m = 20,000 - maximum of 18,000), which would be more than aforementioned wealthy landlord who had since added a small apartment worth 1m Shekel to his property portfolio (1% X 1m = 10,000 Shekel in tax). To mitigate this, the law included a full exemption for owners whose second and third property together are valued at less than 1.15m Shekel, and a staggered exemption if those additional two properties are valued between 1.15m – 1.4m Shekel.

Are there any sweeteners for owners ?

So far, the government has given two concessions to owners in order to both encourage them to sell their investment properties, and to soften the blow.

The first is a grant of up to 75,000 Shekels against any capital gains tax that is payable upon the sale, so long as they sell by the 1st of October 2017. The second is that the proceeds from the sale (up to around 2m Shekel) can be deposited in to a type of pension product (a 'kupat gemel') which under certain conditions (namely that the funds are kept there for at least 5 years, and that the owner is over the age of 60 when withdrawing the funds from the product) can be taken as a tax free lump sum.

Conclusion

Will this new tax have the desired effect of lowering house prices or will it simply bounce off the proverbial armour as previous measures have done? Time will tell of course, however as and when house prices do cool off, it will most likely be from a combination of factors, rather than any one specific measure.

If you are affected by this new tax, you should contact your specialist real estate tax attorney here in Israel, or contact us here and we will be happy to put you in touch with one.