Analysis

Saga of How Wealthy Israeli Real Estate Investors Got Tax Exemption

'Betterment tax grants' – that's the government's euphemism for what in practice is an exemption for the first nine months of the year from betterment taxes.

A home in pricey German Colony, Jerusalem.
Tomer Appelbaum

The state budget for the current year includes a rather peculiar provision. Although the budget as a whole covers all of 2017 and 2018, this provision appears only for 2017. Actually it only runs until the end of September of this year and provides a government outlay of 300 million shekels ($80 million). That’s the figure that the Finance Ministry’s budget division attached to it as the cost of “betterment tax grants.” That’s the euphemism that the government gave to what in practice is an exemption for the first nine months of the year from betterment taxes.

It’s being made available to sellers of homes bought for investment. More precision is in order, however, because technically of course, it can’t be called a tax exemption. Investors who sell residential investment properties actually do pay the betterment tax, but the government then refunds the tax payment as a grant. That makes it a grant, even though from the perspective of the investors, it’s all the same. The taxes that they would have expected to shell out ultimately stay in their bank accounts.

Secondly, we need to be more exacting when it comes to the term “investor,” because it is not the owner of just any residential property that is entitled to enjoy the benefit, whether you call it a grant or an exemption. The generous benefit from the government is only available to those who own two or more homes for investment (meaning two in addition to the residence in which they live).

Thirdly, in fairness, it should be noted that the exemption or grant is not for the full amount of the tax. There is a ceiling of 85,000 shekels in the tax savings. Since the tax rate on the betterment tax is 25% of the value of the appreciation (meaning the profit) on the home, the exemption provides a full tax savings on those whose profit on the sale is no more than 340,000 shekels.

The major increases in the cost of housing over the past decade in Israel have been grist of the country’s media outlets on a regular basis. The issue also spawned the social justice protests of the summer of 2011 that brought Israelis onto the street in their masses. On the surface, after a decade in which the average cost of housing more than doubled, one would expect that a considerable portion of residential investment properties in Israel would therefore exceed the 340,000 shekels profit threshold, meaning that owners who sell in the first nine months of this year would not enjoy a full exemption in the betterment tax.

But things are not what one would expect on that score either. The betterment tax only began to be collected in 2014 and the tax is only levied on the appreciation of the value of the home beginning that year. It’s calculated on a pro-rata basis over the period in which the seller owned the property.

Information obtained by TheMarker reveals that up to this point, sellers of investment property this year have for the most part been owners who have held it for many years and whose better tax levy is low. The average betterment tax rate that is being paid at this time is apparently only around 5%. If this figure doesn’t change over the course of the year until the end of September, it would mean that on average, investment homes can be sold at a profit of up to 1.6 million shekels without paying any betterment tax.

A select group of wealthy

The tax exemption on 1.6 million shekels in profits is a nice gift from the government to investors in residential real estate, but it is provided to a select group of the wealthy and powerful. There are about 50,000 families in Israel that own three or more homes and therefore can benefit from the betterment tax exemption. It is they and only they that are entitled to a tax exemption. The owners of a second apartment inherited from a grandparent that is now being renting it out will not qualify for the betterment tax exemption if sold because it is only available to those with two investment properties.

Why the discrimination?

So what explains the discrimination involved in only providing the benefit to the wealthiest of investors in residential property? How is it that after imposing the tax only a few years ago, the government is now carving out this exemption?

Finance Minister Kahlon, who heads the Kulanu party, ran in the last Knesset election on a commitment to attempt to bring down the cost of living including housing prices. His policies have included efforts to increase the supply of housing available for sale in the expectation that it in turn would lower the price of housing.

In fact, a separate 1% tax on the value of homes (up to an annual 18,000 shekels per home) was imposed this year on owners of three or more homes. Kahlon pushed for passage of the tax provision in an attempt to rattle owners of a large number of homes, penalizing them for the privilege. At the same time, he wanted to provide them incentives to sell off their extra homes as soon as possible. He is therefore offering those investors – and only them – a benefit in the form of an exemption from the betterment tax on the condition that they do so by September 30 of this year.

All told, the incentive applies to 50,000 families who collectively own about 180,000 investment homes. It remains to be seen what the effect of all of this will be on housing supplies. And it also prompts the question as to how it will affect government revenues. Will the state collect more from the 1% tax on owners of three or more homes or will it end up losing more from the betterment tax exemption?

The argument could be made that state might have spared the country the uncertainty if it had taken a different approach and focused on rental income from residential property owned by investors large – and small. There is such a tax but the first 5,000 shekels a month in rental income is exempt. We asked the Tax Authority what proportion of those families owning three or more homes pay tax on rental income but did not manage to obtain a response.