Taxing Apartment Purchases in Buildings Slated for Demolition
The district court’s 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 seek to change the zoning of those properties.
The court’s ruling and the judges’ comments clarify when the purchase tax rate prescribed in the Real Estate Taxation Law for residential apartments applies and when the rate for land purchases applies. The ruling indicates that the answer depends, among other things, on the time between the signing of the purchase agreement and the building’s demolition, and on how the apartments are used during that period.
In the Ahuzat Allenby case, the appellant, a limited liability company, purchased a two-story building designated for preservation. Under the building permit, some units were designated for residential use and others for office use. In practice, all units were leased for residential use, including those designated as offices. From the purchase date through the date of the ruling, the building remained standing, and the appellant continued to rent out all units as residential apartments.
The appellant claimed that it purchased the building with the intention of demolishing it within the preservation limitations, rebuilding it and adding three storeys for vacation apartment rentals. It argued that the transaction was a purchase of land or a building, rather than residential apartments, and should therefore be subject to purchase tax at 6%.
The Israel Tax Authority (ITA) argued that the appellant had purchased residential apartments. Accordingly, it charged the statutory purchase tax rate for residential apartments (8%-10%) on the spaces designated for residential use under the building permit, and 6% on the nonresidential spaces.
The Tests for Defining a “Residential Apartment” for Purchase Tax Purposes
The court examined whether the definition of “residential apartment” in Section 9(c) of the Real Estate Taxation Law was met for purchase tax purposes. It considered the two criteria specified in that section: an objective test, which examines whether the apartment is actually used for residential purposes, and a subjective test, which examines whether it is intended to be used for residential purposes.
The court first examined the subjective criterion and found that it was satisfied: 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 vacation apartments, it also found that the appellant knew it would take five to six years just to obtain the building permit. Until then, the appellant intended to continue renting out the apartments for residential purposes and earn millions of shekels in profits from that use, as it indeed did.
The Court’s Ruling: Purchase Tax on Apartments Intended for Long-Term Residential Use in Buildings Slated for Demolitionn
The court emphasized that it could not accept a situation in which the appellant rented out the apartments for residential use and generated millions of shekels in profits over a long period, yet was taxed as though it had purchased land.
In other words, where a subjective intention to continue using the purchased apartments for residential purposes over a significant period, even if not indefinitely, can be established, the building will be classified as a residential apartment building rather than land for purchase tax purposes.
The court pointed to several facts demonstrating the appellant’s intention: it had extended the existing leases and had not submitted any documentation of efforts to advance the building’s demolition in compliance with the preservation requirements.
The court then examined the objective criterion and found that it, too, was satisfied, as the purchased apartments were actually being used for residential purposes. In this context, the court emphasized that the term “used” can encompass a situation in which an apartment was and continues to be used for residential purposes, without the buyer necessarily having to live in it first.
The court therefore rejected the appeal and adopted the position of the Real Estate Tax Administration, which had applied the purchase tax rate for residential apartments to units designated for residential use under the building permit, and the 6% rate to the remaining units, which were not designated for residential use.
Warning to Taxpayers: The Court’s Approach to Artificial Attempts to Obtain Tax Reductions
Two important statements by the court are worth noting. The first serves as a warning to taxpayers: an artificial attempt to manipulate an apartment’s use solely to reduce tax liability will be addressed under the artificial transaction rules in Section 84 of the Real Estate Taxation Law. This could apply, for example, where the residential apartment tax rate is more favorable to the buyer, who continues using the apartment for residential purposes solely to obtain that rate and demolishes it immediately afterward.
The court directed its second statement to the ITA, noting that its longstanding position had been that an intention to demolish a building meant the transaction should be treated as a purchase of land, regardless of the building’s actual residential use. In this case, however, the ITA emphasized the building’s actual residential use despite the intention to demolish it. The judge instructed the ITA to apply its position consistently, regardless of whether the outcome benefits the administration.
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