Your taxes: When Are Landlords in Business?
This matters, because on residential rental income, individuals may be as low as 10% if the rental income is passive compared with marginal rates up to 50% if the rental income is from an active business. On the other hand, only active business losses can be offset against other income that year, such as salary or capital gains, or carried forward and offset against any business income or gains in later years.
In the last three years, the Israeli District Court twice ruled that owning 20 – 30 residential and commercial properties may still be passive. In the Leshem Case, two lawyers, a brother and a sister in a law firm, happened to inherited 27 properties from their late father and let their secretary and bookkeeper continue handling the rental activity. In the Biran case, a busy property lawyer owned 21 -25 properties over the relevant years but delegated the rental activity to a team consisting of a property developer, a bookkeeper and a maintenance person. On January 2, 2018, the Israeli Supreme Court overturned both District Court decisions in one combined judgment and ruled that renting out 20-30 properties, residential or not, is an business active operation (Civil Appeals 7204/15, 8236/16). The Judge (D.Mintz) wrote: “I am unable to accept the claim that 27 properties are a “modest” amount of lettings…like a few properties” (Para. 63)
So where is the dividing line between passive and active lettings? On February 7, 2018, the ITA issued a draft Circular discussing the Supreme Court judgment and clarifying its own somewhat conservative position in this regard.
Draft ITA Circular Position:
The draft ITA Circular says that renting out up to 5 homes may be assumed to passive. Renting out 10 or more homes should be classified as an active business operation. Renting out 6 – 9 apartments will be tested by reference to general business criteria in the draft Circular which refers extensively to the Supreme Court judgment. The draft Circular does not cover vacation homes nor other business properties.
The Judgment reviews the business criteria and concludes that an operation with employees and a large quantity of activities signify a business (Para.66).
The draft ITA Circular quotes the Judgment extensively and lists: type of asset, method of finance, period the property is held, familiarity with the sector, business set-up, frequency of transactions and activities, financial size of transactions, degree of entrepreneurship (improvements and marketing), and the ‘’over-riding test” of the facts and circumstances. The ITA says that not all these factors need be relevant in all cases. These tests are applied cumulatively with regard to the circumstances in a manner that allows a degree of discretion (i.e. of the ITA…).
The ITA goes on to say that when income is generated in a continuously systematic and frequent way, and this is linked to personal effort the human capital of the taxpayer or his delegate, this is a significant indicator of a rental business.
What the ITA knows about us…
To show it means business, the ITA announcement of February 7 included a table summarizing how many homes landlords hold in Israel, according to an ITA database as of November 2017.
Strangely, this table has since been removed from the ITA website.
In case you missed it, the table indicated that: 1,903,845 individuals hold one home, 219, 452 individuals hold 2 homes, 43,172 individuals hold 3 homes, 10,749 individuals hold 4 homes, 3,517 individuals hold 5 homes, 1,381 individuals hold 6 homes, 676 individuals hold 7 homes, 358 individuals hold 8 homes, 188 individuals hold 9 homes, 401 individuals hold 10 or more homes. That accounts for 2,183,739 homes in total.
Some doubt the accuracy of such data. What about homes held via companies? And was the data presented as a warning to pay the correct tax on Israeli property, not just as a statistical oddity?
Anyone renting rooms online should note the ITA has indicated this too amounts to a business if there are frequent lettings.
But the three-or-more homes tax law was struck down in 2017 by the Israeli High Court (Bagatz) as being enacted too hastily one night, and has not been re-enacted.
More issues arise at the macro level. What about Israeli investors in foreign property? And foreign investors in Israeli property? If they use property managers are they in business if they hold six or more properties in all countries? Supposing they are elderly and/or disabled and clearly unable to run their own business?
Finally, does the ITA have authority to rule that owning above 5 – 10 homes means an active business exists?
As always, consult experienced tax advisors in each country at an early stage in specific cases.