Your Taxes: Israeli property flip ends with a costly VAT lesson

There has been a recent flurry of important real estate tax cases in Israel. They relate to hotel companies, property flips, and transparent house property companies. Below, we review a problematic VAT case involving a property flip (quick onward sale of the property).

VAT case:

The Israeli District Court recently ruled that a taxpaying entity could not change its mind. The taxpayer wanted to refund VAT it incorrectly recovered on the purchase of a residential property in order to avoid a much higher VAT bill on the sale of that property. This case is potentially relevant to many investors in Israeli homes. (Twenty Four Seven International Holdings LLC v. Central Tel Aviv VAT Director 18654-10-22 of 25.6.26, Judge H. Kirsch).

Background:

The taxpayer was an American limited liability company (LLC) which was an Igud Mekarka-in (Hebrew legal term for a real estate association or entity) for Israeli tax purposes. This is an entity in which all the assets are rights to Israeli real estate. Taxes potentially include corporate income tax and sometimes VAT.

The LLC in this case owned an old building in Tel Aviv, consisting of residential apartments (89% of the floor space) and shops (11% of the floor space). The taxpayer purchased its interest in 2008 for NIS 3.7 million plus VAT at 15.5% (then around NIS 574,000).

The VAT office allowed the taxpayer to recover the input VAT on the purchase, as it said it intended to do a flip.

Subsequently, the taxpayer retained and rented out the apartments and shops for a good rent. It only sold the property eight years later, in 2016, for the much higher amount of NIS 33.34m.

So did VAT of around NIS 5.7 million apply to the sale price at the prevailing rate (then 17%, now 18%) as the taxpayer waited eight years before selling?

The taxpayer claimed it had incorrectly recovered VAT on the purchase and should be allowed to change its mind in order to avoid VAT on the sale. The Court disagreed.

Court judgment:

The Court ruled that full VAT applied to the sale price of NIS 33.4m. and the taxpayer could not change its mind.

What are Israel’s VAT rules for real estate?

A business can recover VAT on its purchases but only if the purchases are used to generate sales liable to VAT (VAT Law Sec. 41).

In the case of Israeli residential real estate, a VAT exemption applies to rental income if the lease does not exceed 25 years (VAT Law Sec 31(1)). Therefore, people who rent their homes in Israel do not pay VAT to their landlord.

And when selling a home in Israel, a VAT exemption applies to the sale if, “by law,” it was not possible to recover input VAT applicable at the time of the purchase.

However, if it was determined that part or all the input VAT on the purchase was recoverable, a pro rata VAT charge then applies upon sale (VAT Law Sec 31(4)).

In this case, the taxpayer had purchased the property and recovered all the VAT on the purchase price in order to limit its immediate cash outlay.

Eight years later, in 2016, the taxpayer sold the property and wanted a full exemption on the entire NIS 33.4m. sale price in order to reinvest in US real estate. The taxpayer claimed that “by law” the VAT office should never have allowed it to recover input VAT on 89% of the purchase price of NIS 3.7m. in 2008.

The Court ruled you can’t have it both ways by changing your mind. The residential apartments were rented out for eight years, and input VAT on the purchase should not have been recovered. But since the input VAT on the purchase was recovered, full VAT applied to the sale.

The Court denied the taxpayer permission to pay back the input VAT on the purchase to the Tax Authority.

Comment:

If you are contemplating investment in Israeli real estate, it is critical to check out the long-term implications in all countries. That includes checking out the structure and anticipated VAT implications upon purchase, upon renting out, and upon eventual sale of the real estate concerned. And if you commit to a quick flip, check the consequences if you change your mind and keep the property for a few years.

Wishing readers a happy and prosperous new year.

As always, consult experienced professional advisors in each country concerned at an early stage in specific cases.

leon@hcat.co

The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.