When a person accumulates losses, they can serve as a valuable tax asset. These losses can be offset against their income and capital gains, thereby reducing their tax liability. But what happens when a person passes away and still has losses attributed to them? Do these losses “go to the grave” with them, or can they be inherited by their relatives like any other asset, allowing them to offset future gains?
The tax authority claims that israeli law does not permit the inheritance of losses for tax purposes. The basis for this claim lies in the fact that the Income Tax Ordinances clearly allow the offsetting of a person’s losses only against their own income. On the other hand, there are arguments that a loss is a “property” included in the estate and should be inherited. Additionally, an heir assumes the cost for tax purposes of the assets, including losses, transferred to them and will be taxed on the profits of the asset even during the period it was owned by the deceased without benefiting from a “new cost” that was revalued near the date of death. Therefore, it is most logical that the heir should also be entitled to “step into the shoes” of the deceased regarding the capital losses held by the deceased and benefit from them. This is an unfair and unjust situation, as only a tax liability can be inherited, not a “tax right.”
As with many legal issues in Israel, the root of the problem is the lack of clear legislation on the matter, leaving it open to interpretation and repeatedly bringing it before the courts – without any decisive rulings on losses and inheritances, resulting in recurrent litigation on the inheritance of losses. The solution, of course, lies in early planning and consultation with a tax professional – a lawyer, accountant, or tax advisor.
For the sake of discussion, it is important to note that the inheritance of losses is not an unreasonable idea. For instance, there are countries that allow the inheritance of losses in certain cases. In Austria and India, the law permits the inheritance of losses to heirs who continue the business activity of the deceased. In Canada, in the case of a deceased person with financial losses who bequeaths the losses, it is possible to sell the deceased’s assets and offset their profits against the deceased’s accumulated losses. In the USA, although it is prohibited to inherit losses, they can be traded and sold from person to person as a legitimate asset – thus making the inheritance of losses a type of financial instrument.
The Evolution of the Issue of Inheriting Losses in Israeli Courts
The Tax Authority’s position received support from the court in two notable rulings in recent years that addressed the issue:
Shraga Brothers Case – The Conservative Approach to Inheriting Losses
The brothers Binyamin and Uri Shraga inherited a bakery in Bat Yam from their mother. In the same tax year of their mother’s death, they closed the business and sold it for three million shekels. Upon the sale, they were required to pay real estate appreciation tax on the difference between the original purchase cost and the sale value. The brothers sought to offset the real estate appreciation tax with the total losses the business had accumulated while it was owned by their mother. Had their mother been alive at the time of the sale, this would have been legal and permissible.
The brothers appealed to the Tel Aviv District Court in 2015. Judge Harry Kirsch, who ruled on their case, determined that the language of Section 28 of the Income Tax Ordinance, which refers to the possibility of offsetting losses, pertains only to the individual who accumulated the losses. He added that even if they had continued to operate the business, the law would not have permitted the offsetting of the deceased’s losses with the heirs’ profits. Judge Kirsch noted in his ruling that allowing the inheritance of losses to the appellants would lead to a future situation where losses could be transferred from person to person, even while they are alive – an unreasonable situation.
Dinstein Case – Troubles or Changes in Inheritance Law?
On January 14, 2020, a ruling was issued that rejected the appeals of the late Zvi Dinstein’s daughters, who claimed losses of 2.6 million NIS from his profession and an additional 46 million NIS in capital losses. His daughters sought to claim his losses as his heirs. The appellants contested the ruling, arguing that the Shraga case ruling should not apply to them because their case did not concern the inheritance of business losses but rather another aspect of taxation – the inheritance of capital losses. They also claimed that the Shraga ruling was fundamentally flawed.
District Court Judge Magen Altuvia ruled that the language of the law does not permit the inheritance of capital losses either. Additionally, Judge Altuvia expressed his concerns that the public treasury could be severely affected by the expansive possibility of inheriting losses. He noted that it is the legislator’s role to address this situation, not the court’s, even though the outcome is unjust.
Intergenerational Tax Planning – What Does the Tax Authority Say?
So, is the matter of inheriting losses conclusively closed? Is there no way to prevent the loss of accumulated losses that a person did not manage to utilize during their lifetime? The legal debate on this issue is likely not over yet, but the emerging conclusion is the paramount importance of tax planning in intergenerational transfers, planning that should be carried out by a professional – a lawyer or tax advisor. There are tax planning strategies that help address the issue and allow for the inheritance of losses, but such tax planning needs to be done in advance, while the testator is still alive.
For example, in the Dinstein case, had the daughters inherited shares of a company with losses and continued its activities, the company under their ownership would likely have been entitled to offset the losses (unlike the situation of purchasing the shares).
Our office specializes in intergenerational tax planning that allows for the legal and efficient inheritance of losses. Our general recommendation is to address the issue of losses and their potential inheritance as early as possible, and, as mentioned, while the testator is still alive to present them with the topic of loss inheritance legislation. In our opinion, this is a matter of dealing with unfair, uneconomical, and unreasonable tax policy, which should and can be addressed with minimal damage when assisted by an accountant or tax advisor.
Our recommendation is to incorporate tax planning that addresses intergenerational transfer in the tax field. To schedule a meeting with a tax attorney regarding the tax implications of a will or inheritance, please contact our office.
