Taxing of apartment purchases in buildings slated for demolition

The district court’s position in its recent ruling in the Ahuzat Allenby Ltd. case has significant implications for investors, developers and private individuals who purchase apartment buildings slated for demolition and are looking to change the zoning of the purchased properties.

The court’s ruling and comments made by the panel of judges clarify in which instances the purchase tax rate prescribed in the Real Estate Taxation Law will apply to residential apartments and in which instances the tax rate prescribed for land purchases will apply. The ruling indicates that the answer to this question depends, inter alia, on the timeframe that elapses from the signing date of the apartment building purchase agreement and the date of its demolition, and on the use made of the apartments during that timeframe.

In the Ahuzat Allenby case, the appellant, a limited liability company, purchased a two-storey building designated for preservation. According to the building permit, some of the units in the building are zoned for residential use while others are zoned for offices. In practice, all of the units were leased for residential use, including the space zoned for offices. After the purchase date and up until the date of the court ruling, the building had not yet been demolished and the appellant continued to rent out all of the units as residential apartments.

The appellant is claiming that it purchased the building with the intentions of demolishing it within the preservation limitations, rebuilding it and adding three storeys to be used for vacation apartment rentals. The appellant’s position is that at issue is the purchase of land or a building and not the purchase of residential apartments, and therefore, it should be charged purchase tax at the rate of 6%.

The Israeli Tax Authority (ITA) argued that the appellant purchased residential apartments and accordingly, charged it the statutory purchase tax (8%-10%) in respect of the spaces zoned for residential use according to the building permit and purchase tax at 6% in respect of the nonresidential spaces in the building.

The tests for defining a “residential apartment” for the purpose of purchase tax

The court examined whether, under the circumstances, the definition of “residential apartment” for the purpose of purchase tax, prescribed in section 9(c) of the Real Estate Taxation Law ,is met,  according to the two criteria specified in the section – an objective test, which ascertains whether the apartment is actually being used for residential purposes, and a subjective test, which ascertains whether the apartment is intended to be used for residential purposes.

The court first examined the subjective criterion and ruled that it was satisfied, under the circumstances – i.e,  the appellant had purchased apartments intended for residential use.

Although the court accepted the appellant’s claim that it planned to demolish large sections of the building and construct apartments to be used as vacation apartments, the court also ruled that the appellant had been aware that it would take five to six years just to obtain the building permit and that, until then, it intended to continue renting out the apartments for residential purposes and to reap millions of shekels in profit from their very existence as residential apartments, as was indeed the case.

The court ruling: the tax rates on purchases of apartments to be used for residential purposes over a long period, in buildings slated for demolition

The court emphasized that it cannot accept a situation whereby the appellant rents out the apartments as actual residential apartments, generates millions of shekels in profits from them over a long period and is still taxed as if it had purchased land.

In other words, in instances when a subjective intention to continue using purchased apartments as residential apartments over a significant period (even if not indefinitely) can be proved, the building will be classified as a residential apartment building and not as land for purchase tax purposes.

The court pointed out several facts that showed that this was indeed the appellant’s intention – it extended the existing leases and also did not attach any documentation of its attempt to advance the demolition of the building while complying with the preservation requirements.

The court then examined the objective criterion and ruled that it was also satisfied, under the circumstances, and that the purchased apartments are actually being used for residential purposes. Within this context, the court emphasized that the term “used” can include any situation in which the apartment was used and is continuing to be used for residential purposes objectively, without the buyer necessarily having to live in it first.

In conclusion, the court rejected the appeal and adopted the position of the Real Estate Tax Administration, which charged purchase tax at the rate for residential apartments in respect of the units zoned for residential use according to the building permit, and charged purchase tax at 6% in respect of the rest of the apartments, since they were not zoned for residential use according to the permit.

Warning to taxpayers: the court’s attitude towards attempts to artificially obtain tax reductions

It is important to note two of courts important statements. The first serves as a warning to taxpayers – if an artificial attempt is made to manipulate use of an apartment solely for the purpose of reducing the tax liability, the case will be handled according to the artificial transaction rules in section 84 of the Real Estate Taxation Law. For example: in an instance whereby the optimal tax rate for the apartment buyer is the tax rate on a residential apartment, so the buyer continues to use the apartment for residential purposes only in order to receive a reduced tax rate, and immediately thereafter, demolishes the apartment.

The court addressed its second statement to ITA, and stated that  it should take into account that its position over the years had been that an intention to demolish is tantamount to a purchase of land, without considering whether the building is actually being used for residential purposes, while in this case, the  ITA emphasized that the building was actually being used for residential purposes, notwithstanding the intention to demolish it. The judge instructed the ITA to be consistent and systematically follow its own position, regardless of the outcome – i.e., whether or not it benefits the administration.

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