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Data show rental market is haven for tax evaders

Israel has been enabling landlords to evade taxes: A list released by the Israel Tax Authority on Wednesday revealed that a disproportionate number of all settlements reached on unpaid back taxes in 2017 were made with owners of rental apartments.

The settlements were reached after officials agreed to drop lawsuits to recover unpaid taxes in exchange for taxpayers making good on what they owe plus penalties. Among 283 settlements reached last year, 114 were in the real estate sector and a large part of those involved landlords of residential properties.

The rental market has long been recognized as a haven for tax evaders, who stand little chance of being caught. The reason is that landlords are exempt from reporting their rental income at all if their monthly income is less than 5,090 shekels (about $1,500). Above that amount, they are liable for a tax of either 10% of income or 30% of profits.

Unlike other sectors of the economy, where even tax-exempt income must be reported to the authorities, in the rental market, income under the threshold need not be reported at all. Without a complete and organized record of landlords and a record of all their income, Israel has turned into a Garden of Eden for tax evaders.

The dizzying rise in rents in recent years and the huge number of transactions further encourage tax and capital laundering offenses. What’s more, in an era of near-zero interest rates, many small investors have discovered the residential real estate market as an alternative to bank deposits and other traditional channels.

Investing in residential real estate is relatively easy and generates two income streams – one from rental income and the other from the rising value of the property. Unlike the stock market, investors can leverage their capital by taking out a mortgage, and their income below the threshold is tax free.

Finance Minister Moshe Kahlon inadvertently exacerbated the phenomenon by raising the purchase tax on houses bought by small investors. The supply of rental properties shrank and rents rose as investors – far from abandoning the real estate market – began investing in homes overseas.

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Tax officials have far better access to information on property ownership in Israel; getting that data from overseas is far more difficult and investors have access to many tax-avoidance tools.

It should be noted that the tax amnesty program, which followed a major crackdown, only address taxpayers with domestic properties.

Among the 49 reported settlements made with residential landlords, the biggest involved foreign residents owning properties in Israel. They were topped by one for 570,000 shekels on unreported income of 3.8 million and another for 465,000 shekels on 3 million in undisclosed income.

Most landlords in Israel have income from other sources and their rental income is supplementary. However, among the 49 to reach settlements, rental income was quite significant – 13 of them had unreported income of 1 million shekels or more.

The tax authority says that most of those who are caught claim they didn’t know that rental income had to be reported at all. In some cases, however, the evaders clearly tried to avoid paying taxes they knew they were liable for by, for instance, registering an apartment in the name of a relative.

The tax authority stresses that tax is liable on the person who receives the rental income, not the person who is listed as owning the property.

Among the other consequence of Kahlon’s policies, which were aimed at stemming rising home prices, was an inadvertent decline in housing supply, increased demand and soaring rents. The result is that thousands of units in the center of the country, where rentals are the highest, rose above the threshold level for reporting to the tax authorities.

For many landlords this created a dilemma – to keep rent under the threshold to avoid reporting or raise it and pay taxes.

Many tenants have encountered that third option, when they are asked to pay the first 5,000 shekels of rent by check or bank transfer and the rest in cash.

The tax authority is aware of the problem and in 2017 launched a stepped-up enforcement program against tax evaders, with the aim of deterring the many others not caught up in it. Its main problem remains identifying apartment owners at all.

There are no official figures on the number of rental apartments in Israel. The treasury publishes figures every month on the change in the number of properties owned by investors, but it doesn’t provide data on the total number of properties they own. Estimates range between 500,000 and 600,000, most of them in the center of the country.