Tax implications of buying real estate in the US - how should you own the property?
The United States has always been an attractive destination for real estate investments. The protests that began following the legal reform have only strengthened the motivation of many Israelis to invest in real estate abroad, and the United States is, as expected, one of the most sought-after destinations for purchasing properties. Many Israelis are undecided about whether to make a direct investment in American real estate. For example, investing in an apartment in the United States, a private house in the United States, or a unit in a so-called multifamily, versus an indirect investment through a REIT fund or shares of real estate companies. However, even after you have decided which property in the US you want to buy, you still need to consider all the necessary factors for the investment to be successful.
For example, how to own the property and with whom to register it? These are some options:
- Direct possession of the property in the name of one of the spouses.
- Direct possession of the property in the name of two or more spouses.
- Holding through the establishment of a transparent American LLC-type company in the name of one of the spouses (Single Member LLC).
- Holding through the establishment of a transparent LLC in the name of two or more people.
- Possession through the opening of a transparent American LLC in the name of an Israeli limited liability company (Single Member LLC).
- Possession through the opening of a transparent American LLC-type company in the name of two or more individuals.
- Possession through the registration of a closed American C-Corp (Inc) company.
- Possession through the registration of a transparent S-Corp-type company.
- A combination of any of these options (for example, an Israeli limited liability company that owns a closed American C-Corp, etc.).
- Financing the property through a loan from a US bank, a bank in Israel, or self-financing.
Each of the alternatives has an effect on the taxes that will be paid in the transaction. The choice of the holding method is of critical importance since it’s essential to remember that there are several goals you want to achieve when choosing the holding structure. For example:
- Protection of the property owners from lawsuits (which in the US may reach astronomical amounts). This protection is mainly made possible through possession through a company. In the case of “dangerous” assets, the structure also addresses this, further reducing the risk of payment for a claim.
- Protection from estate tax. It’s important to remember that the United States has an estate tax. The estate of a person who is not a US citizen is subject to estate tax at a rate of up to 40% beyond the low exemption. Holding property through a company (that is not a transparent LLC) generally protects against estate tax. There are different ways to protect against estate tax, each with advantages and disadvantages.
- Current costs of reporting in the US over the years. When it comes to an LLC-type company held by a single entity (Single Member LLC), it’s possible not to submit a report to the tax authorities in the US but only for the “member,” i.e., for the person who owns this company. Savings in submitting reports over the years can add up to thousands of dollars and can affect the yield and certainly the risk.
- Exploiting profits that exist in an Israeli company owned by the investors. Sometimes it is useful to avoid dividend distribution in an Israeli company and use it to buy the property in the US. Is the purpose of the investment “passive” rents or alternatively active “flips” in which a property is purchased, renovated, and sold? Is the main purpose capital gain (short-term? long-term?) Maintaining the value of money when it is linked to the dollar? The best tax result should consider taxation in both countries! Usually, an American accountant will give the best solution considering only the USA, and an Israeli accountant will give the best solution considering Israel. The challenge is to find a result that will be good considering the tax systems of both countries!
So, what should we do?
The first step would be, in almost every alternative, to establish a transparent LLC and purchase the property through it. The advantage in the US is that only when submitting the report is there an obligation to choose who owns the company (of course, for the Israel Tax Authority, you must know this before submitting the annual report, which may not always have the same deadlines). After this stage, it is advisable to seek a consultation to make a joint decision on how to register the property.
How to Transfer Money for Property Purchase
Converting the Money to Dollars:
Converting and transferring money through a bank can be costly due to the bank’s various fees and exchange rate disparities. Banks often employ multiple rates for conversion, such as the transfer rate, purchase checks rate, sales checks rate, cash purchase rate, cash sale rate, and the Yitzig rate published by the Bank of Israel. The gaps between these rates can be significant, sometimes exceeding 5% in the case of the US dollar and even approaching 8% for less commonly used currencies. To minimize conversion fees, working with non-bank entities approved by the Ministry of Finance can reduce costs to an average of half a percent.
Tax Authority Approval for Money Transfer:
The United States has a double taxation treaty with Israel, eliminating the need for tax authority approval when transferring money for property investment purposes. You can simply complete a form at the bank to confirm the transfer as long as it is indeed intended for property investment in the USA.
Opening a Bank Account:
Several options exist for opening a bank account in the USA, ranging from physical banks like Bank of America (which can also be accessed from Israel) to virtual banks with automatic transfer and conversion mechanisms to shekels and your Israeli account. Our office collaborates with parties in both Israel and the USA who facilitate the efficient, cost-effective, and secure opening of bank accounts.
Choosing Currency Linkage:
Deciding whether the investment should be linked to the shekel or the dollar is an important consideration. Changes in the credit rating of the USA can affect the dollar, while shifts in the Israeli political landscape can impact the shekel. Depending on investors’ preferences, it’s possible to hedge the investment against currency fluctuations using mechanisms like options on the dollar exchange rate or loan arrangements tied to the dollar. During the consultation, the feasibility of currency linkage is also explored.
Tax Implications:
Selecting the appropriate tax route in Israel and the US is crucial for maximizing the return on investment. In the US, federal tax applies, and some states impose state and municipal taxes. Short-term capital gains are subject to marginal tax rates, while long-term gains (held for over a year) are taxed at a federal rate of 20%, with additional state taxes where applicable. The absence of a purchase tax in the US simplifies real estate investment. In Israel, rental income can be subject to a 15% tax on income minus depreciation or a marginal tax rate minus all expenses. In specific cases, concerns may arise about the Israeli Tax Authority categorizing an investment as active, resulting in a marginal tax rate of up to 50%. Additionally, if control and management of the American company are conducted from Israel, registration in the Companies Registry and separate reporting to the Tax Authority are required.
Should the Investment Be Linked to the Shekel or the Dollar?
It’s essential to consider whether the investment should be tied to the shekel or the dollar. Keep in mind that changes in the USA’s credit rating can negatively impact the dollar, while regime changes in Israel can have a detrimental long-term effect on the shekel. Depending on each investor’s preferences, it’s possible to secure the investment’s linkage to the shekel, dollar, or another currency. Such linkage can be established through mechanisms like options on the dollar exchange rate or as part of investment financing, such as loans pegged to the dollar, among other options. As part of the consultation process, the feasibility of implementing the desired currency linkage is also thoroughly evaluated.
How much tax will be paid on the property?
Choosing the taxation route in Israel and the US is critical to achieving a good return on the investment. In the US, there is federal tax, and in some states, there is also state tax, along with municipal tax in some cases. Short-term capital gains are taxed at marginal tax rates, while long-term capital gains (held for more than a year) are taxed at a federal rate of 20%, with additional state tax where applicable. The absence of purchase tax in the US makes real estate investment there more straightforward. In Israel, regarding rental income, one can typically choose between a 15% tax on income minus depreciation or a marginal tax rate minus all expenses. In certain cases, there may be concerns that the Israel Tax Authority will categorize a specific investment as active and subject it to a marginal tax rate (up to 50%). It should also be noted that if control and management of the American company occur from Israel, it is necessary to register it in the Companies Registry and report it separately to the Tax Authority.
The Consulting Process
As part of the consulting process, we meet with the client for an initial consultation meeting to understand their needs and explain the existing exposures and options. Following that, we prepare a detailed document for the client, outlining all relevant options tailored to their specific situation. This document takes into account the client’s specific limitations, the advantages and disadvantages of each option, and our recommendation regarding the appropriate course of action. This includes how to purchase the property, how to hold it, how to convert the funds, which currency to peg the investment to, how to report in the US and in Israel, and which tax route to choose, among other considerations. After this phase, we refer the client to companies that assist with fund conversion, opening bank accounts, US reporting, and any other relevant aspects of making the investment, providing assistance with all necessary connections.
In conclusion, buying a property in the USA can be a profitable endeavor, but careful planning and proper procedures from the outset are crucial for its success.
