1. The Tax-exempt Route
The Tax-Exempt Route Under the Income Tax regulations, several conditions must be met to qualify for a tax exemption on income from residential rent in Israel:
a. The property must be rented to individuals for residential purposes only, not for any business activities.
b. The property owner must have a written contract with the tenant stating the aforementioned condition.
c. The total monthly income from all apartments rented by the owner (including their spouse or children up to the age of eighteen) must not exceed the specified exemption amount.
As of 2021, the exemption ceiling is NIS 5,070, with annual updates.
d. If the total monthly income exceeds the exemption ceiling but remains below twice the amount of the ceiling (NIS 10,140), the exemption will be reduced by 1 shekel for each shekel above the ceiling. The reduced portion will be subject to the applicable marginal tax rate.
For example:
A. Monthly rental income is NIS 4,500.
Since the income is below the exemption ceiling, the landlord will not pay any taxes.
B. Monthly rental income is NIS 8,000. The income exceeds the ceiling by NIS 2,930 (NIS 8,000 - NIS 5,070 = NIS 2,930). We deduct this amount from the ceiling to calculate the adjusted ceiling (NIS 5,070 - NIS 2,930 = NIS 2,140). The adjusted ceiling becomes NIS 2,140.
*For simplicity, we can subtract the rental income from twice the ceiling:
NIS 10,140 - NIS 8,000 = NIS 2,140.
The new taxable income is NIS 5,860 (NIS 8,000 - NIS 2,140 = NIS 5,860).
In cases of partial exemption, landlords can deduct a proportionate share of ongoing expenses related to the rental, such as lawyer's fees, management fees, and broker fees.
2. Reduced Tax at a Fixed Rate
Reduced Tax at a Fixed Rate This route offers a fixed tax rate of 10% under the following conditions:
a. The apartment is solely used for residential purposes.
b. Rental income is not classified as business income.
It's important to note that the Income Tax Authority may classify rental income as business income beyond a certain number of apartments.
For example, if the monthly rental income is NIS 15,000, the landlord will pay NIS 1,500 in taxes (10% of NIS 15,000).
This route does not allow for deductions of ongoing expenses incurred by the landlord, such as repairs, attorney's fees, and management fees.
3. Billing According to Tax Brackets
In this route, the landlord's marginal tax rate is determined based on their total income. All ongoing expenses related to the rental can be deducted under this route.
For rental income, the initial tax bracket is 31%, except for landlords who turn sixty in the tax year, for whom the initial tax bracket is 10%. It's important to note that choosing this route requires submitting an annual report to the income tax authority.
Business vs. Passive Income
If residential apartment rentals are classified as a business, income tax rates applicable to business income will be imposed, and the tax benefits of the exemption and reduced tax routes mentioned above will not apply.
Several tests determine whether rental income is considered passive or active business income. According to the Tax Authority, renting more than 10 apartments indicates the existence of a business. Renting less than 5 apartments is classified as passive income that is not considered a business. Renting more than 5 apartments but less than ten requires additional tests to determine the income classification.
Conclusion
The choice of taxation route can be changed on a yearly basis, usually depending on the rental income earned. The exemption route is commonly advantageous for single property owners. We strongly recommend seeking professional advice to determine the optimal tax route for your situation.
If you are in need of tax advisors or are interested in investing and property management, feel free to contact us to make the most out of your shekels.
