27.01.2013

The California gold rush of 1848 to 1855 attracted people from all over America.
The California gold rush of 1848 to 1855 attracted people from all over America. Now a new rush is under way to find United States real estate at bargain-basement prices, and it is attracting Israelis and many others. If you are one of them, make sure it’s all on solid foundations   physically, fiscally and legally speaking.

Israeli investors in US real estate will want to minimize taxes in each country. The US IRS wants tax on their US real estate. The Israel Tax Authority wants tax from Israeli residents unless they are new immigrants.

Therefore you need to plan with tax advisers in each country various aspects, including:
   Entities: company, partnership, trust, REIT
   Transactions: long-term investing, short-term flipping, development projects, etc.
   Finance: local or international
   Avoiding double taxation: credit for federal and state US taxes against Israeli tax in the right tax year
   Repatriating income
   Exit strategy.

Israel’s tax treaty with the US helps, but only partly. Consider not only income tax but also state and local taxes, stamp taxes, estate taxes and so forth.

Tax rates
US federal tax rates typically range up to 35 percent, and dividends paid to Israeli shareholders with at least 10% are generally taxed at 25% in the US according to the USIsrael tax treaty. As for capital gains, the US federal long-term rate is currently 15%, and there is a withholding- tax mechanism in FIRPTA (Foreign Investment in Real Property Tax Act to help non-US persons pay the tax.

In Israel, foreign passive (non-business) rental income is generally taxable at rates ranging from 30%- 48% after deducting permissible expenses and depreciation at Israeli rates (2%-4% of the building element, not land), less a credit for US federal and state taxes, not city taxes. Alternatively, it is possible to elect to pay 15% Israeli tax of the gross rent after depreciation at Israeli rates, ignoring expenses and US taxes.

It seems you can chop and change from year to year and perhaps even from property to property.

Capital gains are taxed at various rates   typically 25% for properties bought in 2012 on, or 20%-48% for earlier purchases. The Israeli tax calculations are done in shekels and adjusted for Israeli inflation.

National Insurance Institute (social security) obligations are also payable in certain circumstances at various rates   but not on dividends, capital gains or rent taxed at 15% in Israel.

Business operations may be taxed at higher rates; e.g., development for onward sale, frequent sales.

In practice, combined US-Israeli tax calculations should be prepared on a case-by-case basis because the result can vary according to many factors: the amounts, the location, losses, foreign tax-credit rules, whether you are in the real-estate business, etc.

Is an LLC right for you?
A Limited Liability Company (LLC) is much talked about, but be careful.

They can reduce tax layers for Americans living in America and increase taxes for Israeli residents.

For US tax purposes, an LLC is usually a transparent  flow through,  meaning the members (shareholders) are taxed, not the LLC itself.

In Israel, the ITA has published a circular allowing Israeli taxpayers to elect flow-through treatment in the first relevant tax return. This means reporting the LLC income as your own that year and every year and crediting US federal and state tax thereon. If you don’t elect flow-through treatment in that first relevant year, you will generally pay tax on distributions by the LLC-like dividends: 30% in 2012, if you hold 10% or more of the LLC; 25% Israeli tax otherwise, with NO credit for US taxes (the tax rates were 25% and 20% in 2011 and before 2012).

Therefore, the combined US-Israeli tax rates on LLC income and gains can be quite high for Israeli resident investors: 55%- 60% in total sometimes. So look before you leap into an LLC. This also applies to US olim living in Israel. Other structures are usually more tax efficient for Israeli investors.

What else should you watch out for?
Personal investment and LLCs offer no protection against US estate tax; currently US federal estate-tax rates range up to 35%, but they may range up to 55% in 2013 under current legislation. In New York and elsewhere there is also state estate tax. Non-US persons are exposed to US estate tax if they move into the next world holding US assets worth $60,000  a lot less than the minimum threshold for US persons. Other structures such as regular corporations (not LLCs) may afford more protection from estate tax. Or consider life insurance.

If you use an Israeli or offshore corporation to hold US real estate, check out the complicated US branch remittance tax (levied instead of dividend withholding tax). The rate may be 12.5% under the Israel-US tax treaty, or up to 30% otherwise.

In addition, check you financing arrangements. Interest paid by Israeli residents to a US bank, savings institution, insurance company or the like is liable to 10% Israeli withholding tax under the US-Israel tax treaty. The treaty rate is 17.5% for interest paid to other US lenders. Without the treaty, the usual Israeli withholding tax rate is 25%. If you don�t withhold the tax, the interest expense isn�t deductible in Israel. If you do withhold the tax, the US lender may not be able to fully credit the Israeli tax and want to  be made good for it,  which means grossing up the amounts.

Obtain a cash-flow forecast and check that you can repay the finance. In a recent case, an LLC investor was committed to using all LLC profit distributions to repay bank finance, without regard to Israeli (or US) taxes also payable. Ouch. Always have the LLC itself repay loans, not the members.

Israeli investors in an LLC or partnership will typically receive a US tax form K1 showing their share of profits for US tax purposes.

This is usually not detailed enough for Israeli tax purposes; for example, the asset cost and depreciation figures to calculate depreciation at Israeli rates, which are different from US rates. And prepaid rental income is immediately taxable in Israel; so are capital gains from  installment sales (property is sold, but the consideration is received in installments over time). Israeli investors need to agree to additional information availability and to be consulted where possible.

To sum up
Always do your homework before investing in real estate in the US (or anywhere else). The above summarizes just a few of the many aspects that may need to be considered.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

[email protected] Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.