What’s Important to Know When Investing in USA Real Estate Using an
Soaring real estate prices in Israel drive many Israelis to seek real investment abroad. This article focuses on Israeli tax implications of real estate investment in the USA, using an LLC.
So what is an LLC?
An LLC (Limited Liability Company) is an American business structure and an eligible entity. Members of the LLC hold membership certificates and not shares. Investing in an LLC is a convenient way to invest in US real estate. Similar to the Israeli Ltd., its primary advantage is legal protection.
When opening an LLC for US real investments purposes, investors have two registration options: a flow-through entity (also known as transparent), or a corporation. The question is – whether to flow-through or not?
- As a corporation – a separate tax and legal entity that files reports to the US tax authorities just like any other US company. If management and control of the opaque company are non-Israeli, neither Israeli tax liabilities nor ITA (Israel Tax Authority) reporting responsibilities apply. However, if distributing dividends from profits, Israeli members are obliged to report to the ITA. Also, choosing the opaque option investors cannot receive tax credits against foreign taxes paid overseas.
- A flow-through entity – just like in partnerships, for taxation purposes, the profits, or losses are personally ascribed to each member. Every member receives the Schedule K1 Tax Form from the American tax authorities describing the invested amount, ownership percentage, as well as the member’s share of profit or loss. On their share only, members report to the tax authorities, in both the USA and Israel, with the option to deduct the taxes paid in the US against their Israeli tax liability.
In the USA – the default is that an LLC is transparent unless requested otherwise at registration, under the “check-the-box regulations”.
In Israel – Israeli investors can choose how to report; as a corporation, or as a transparent entity, and thereby pay personal taxes for what their investment had produced, whether profit or loss .Within the first year of establishment, Israeli investors must choose whether their LLC is opaque or transparent and report accordingly to the ITA, using the 150 Form discussed below.
Investment, reporting, and tax implications when using an LLC
Investing in real estate in the USA requires filing reports to both American and Israeli tax authorities.
In Israel, when using an LLC for real estate investments, the ITA requires investors to submit the 150 Form with their annual reports. The form confirms that an investor has ownership in a foreign company. Enclosing the form is compulsory from a 10% ownership, regardless of whether the investment had produced profit or loss.
Article 7 to the American-Israeli income tax treaty determines that property “…may be taxed by the Contracting State in which such real or natural resources are situated.” To ensure investors do not pay double taxes on a USA investment, they will pay US taxes on the profit produced from the US asset while in Israel they receive tax credits against the American taxes they had paid.
How much income tax will an investor pay on overseas real estate?
In Israel, there are two options from which investors can choose how to calculate their taxable income:
- The flat 15% option – taxpayers pay 15% tax on their comprehensive income, deducting only depreciation expenses and receiving no tax credits against the taxes paid abroad. (Please note: when real estate investors use an LLC this option does not apply. For example, if an investor holds only a few percentages of an LLC, we often lack information because the profit presented on the Schedule K1 Tax Form is after deducting all expenses, not just depreciation.) We, therefore, recommend choosing the flat 15% option in cases of private investments, or when investors have full ownership and the entirety of information about the asset.
- Paying Bituach Leumi (national insurance; health levy and social security) when choosing the flat 15% option – section 350(A)(7) in the National Insurance Ordinance determines that income from Israel and overseas rent that is subject to limited taxation rates (exempt and 10% in Israel, 15% abroad) is exempt from paying Bituach Leumi.
- The marginal tax option – or in other words, net overseas income. Taxpayers are taxed on the profit made on the foreign investment; offsetting the total costs associated with the management and operating the asset (including depreciation, management fees, maintenance, financing expenses, travel expenses, etc.) from the comprehensive income. Choosing this option, taxpayers pay tax according to their tax bracket. The first tax bracket for overseas income is 31% which can go up to 47%, depending on taxpayers’ overall income. Taxpayers opting for this option receive tax credits against the taxes they had paid abroad.
Paying Bituach Leumi for the marginal tax option – a National Insurance directive exempts LLC members from paying Bituach Leumi on income from real estate investments.
- In Israel, calculating depreciation expenses for an overseas asset is subject to the Israel depreciation rules and regulations. Therefore, if the depreciation expenses had been calculated abroad, they should be ignored and recalculated.
- The income tax authority’s approach toward offsetting LLC losses determines that even if investors had chosen to register the company as flow-through (transparent), they cannot offset the losses of one LLC against income from another. Neither can they offset losses of an LLC against other private passive earnings, overseas, such as interest or dividends.
Capital Gains (CG) Tax
When selling property abroad, the profit is subject to CG tax. For property bought after January 1, 2003, the Israel CG tax is 25%. Selling foreign real estate, an Israeli taxpayer has to report the transaction to the ITA within 30 days. For the federal taxes paid in the USA, Israeli taxpayers receive tax credits and pay taxes on the difference between the USA taxes and the Israel tax.
Under this taxation mechanism, and for purposes of selling real estate in the USA, registering the LLC as transparent is the preferred option because an opaque LLC might expose the Israeli investor to higher taxes.
For taxation purposes, and excluding Greece and France, provided that investments are private or use a transparent LLC there is no difference whether investing in the USA or anywhere else.
Who pays US estate tax?
Investors should acknowledge that both American citizens, as well as foreign investors, are subject to estate tax.
Non-American citizens are exempt from estate tax if on the day of passing property is worth up to $60,000 (for 2018). Taxation for that part of the property exceeding $60,000 is subject to tax brackets and can reach up to 40% tax.
Investing in the US requires far-reaching tax knowledge in both Israeli and American taxation, as well as understanding how the laws and regulations correspond with each other. Furthermore, certain solutions can protect from estate tax. We have the know-how and expertise to advise on how to best manage your taxes and protect your capital and assets. We’d love to hear from you.