Tax Authority Defines Rent Earned from Leasing 10 Apartments or more as Business Income

The Israel Tax Authority (ITA) recently published a draft circular for public comment on the issue of classifying residential rent income. The move comes in the wake of the Supreme Court’s rulings in the Leshem and Biran cases, in which it reversed district court rulings regarding the taxation of income from the leasing of residential apartments.

The ITA elaborates on its interpretation in the draft circular and, unlike the material criteria specified in the rulings, states that, according to its reasoning, income from the leasing of 10 or more apartments should be deemed business income.

In cases of those leasing five to nine apartments, the ITA states that each instance will be evaluated according to the standard criteria (of what constitutes a business), and that the working assumption will be that the leasing of up to five apartments is recognized as passive income and not as business income.

The differentiation between passive income and business income is a critical matter, since if rent earned from the leasing of residential apartments is considered passive income, then section 122 of the Income Tax Ordinance may be applied. Section 122 of the Ordinance imposes a uniform tax rate of 10% on all rental income, rather than a progressive tax rate (up to 47%). Another important point is the possibility of offsetting losses pursuant to section 28 of the Ordinance.

As stated, this is only a draft circular. But a final draft circular on this subject is expected to be published within the next few months. In light of the changes expected in the ITA’s position, we recommend analyzing the existing alternatives with the aim of creating tax optimization in relation to rental income.