How Does the Israeli Real Estate World Operate Under the Taxman’s Radar?

Q1 Homebuyers report shows: The more houses someone owns – the less income he reported earning.

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There couldn’t have been anything less than an embarrassed grin on the face of Finance Ministry Chief Economist Yoel Neveh on Tuesday as he published his first-quarter report on home buying.

Amid all the numbers and analyses was one that stuck out as being highly improbable: The more houses someone owns — namely a property investor — the less income he reported earning.

This figure came from a survey of 200 property investors in the Netanyahu area during the first three months of the year. Those who said they owned one or two homes for investment reported an average monthly household income of 33,000 shekels to 37,000 shekels ($8,600-$9,650).

Strangely, those with three to six homes said they earned just 20,000 shekels. On that income, they succeeded in buying homes that are worth today a combined 6.2 million shekels.

At the far end of this improbable ratio between income and assets, an investor who had bought his 22nd home during the quarter reported his monthly income to the Tax Authority at 8,000 shekels, less than the national average, thereby entitling him to a tax rate of just 10% on his rental income.

The figures reveal how little coordination there is inside the government. The treasury’s chief economist reveals in a report released to the public numbers that the Tax Authority is apparently unaware of.

The Tax Authority defended itself, saying that the kind of tax files that fall between the stools is a thing of the past. In the past year, the authority has begun employing an information database that spots cases where there a strong incongruence between reported income and reported assets.

About 100,000 letters have been sent out, half to people who have more than three houses without the kind of income that could have financed buying them. For now, at least, the taxmen are letting people who have just one or two investment properties to avoid any scrutiny.

Officials believe that the 50,000 letters account for the majority of property investors who have unreported income. They will be targeting those who haven’t been reporting their income from rentals and those who can’t adequately explained how they accumulated the capital to buy two investment homes.

Officials promise this isn’t a one-time operation. People will no longer be able to invest as real estate millionaires while reporting a paltry monthly income.

The treasury’s chief economist looked at other tax aspects of the Israel real estate market. Examining trends over the last decade, he observed that the last time the purchase tax was raised on investors, in 2011, the number of homes bought jumped just before the hike went into effect and then dropped.

Since then the presence of investors in the residential real estate market has been growing and in the first quarter of this year edged close to its 2010 record.

That analysis in very relevant right now because Finance Minister Moshe Kahlon this week got cabinet approval for another increase in the purchase tax sometime in the next few weeks in an attempt to cool the real estate market by deterring investors. The experience of the 2011 tax hike suggests that over the long run it doesn’t work.

Strangely, Naveh missed an important milestone in his graph charting developments in taxes and housing, namely last year’s increase in the property improvement tax. Until last year, investment properties were effectively exempt from the 25% tax on capital gains from sales.

That enabled the entire Israeli real estate world to operate under the taxman’s radar. Because an investor didn’t need to report capital gains, there was no reason to report the investment at all.

Rescinding the exemption is supposed to shine the Tax Authority’s light on property investments because now all transactions for investment purposes have to be reported to the authorities. So far, however, there’s no sign that the reporting requirement has had any effect on the market. As Tuesday’s report showed, investors are buying homes at a faster pace than people are buying home to live in.

On the other hand, it may take time for the improvement tax to have an effect. Investors don’t have to pay it until they sell, so that its impact will take years to assess. But here may be one early indication: In Tel Aviv, the number of homes sold by investors has fallen 20% since 2013. Some observers point to the improvement tax as depressing market activity.

In other words, it’s too soon to measure the effect of the tax crackdown and the tax hikes on the market.