Dear clients,

On Friday, February 24, 2003, the memorandum of the Economic Efficiency Law was published, which includes several proposals in the field of real estate taxation. In addition, the Government Decisions document was updated on the same day.

Below are the main proposed amendments regarding real estate taxation in Israel:

• Relief for the activities of real estate investment funds (REIT funds) – in order to expand the activities of REIT funds and to encourage construction for rental properties, there is a proposal to expand the range of rental properties in which REIT funds are entitled to invest in, so that “yielding real estate for rental housing purposes” as defined in Section 64A2 of the Income Tax Ordinance will include projects in the Negev or Galilee regions with at least 15 rental apartments, as opposed to the current requirement of at least 20 rental apartments. In addition, there is a proposal to shorten the time period from 20 years to 10 years at the end of which the REIT funds will be able to sell the rental apartments to a continuing lessor, in order to encourage the tradability of the rental apartments. Further, and in exceptional cases, there will be an extension of 2 additional years for the occupancy requirement period for rental apartment projects.

• Urban renewal for owners of rights in more than one housing unit – the tax exemption for owners of an apartment under an urban renewal project is currently granted only to owners of rights in 1 apartment per seller per building. In order to encourage urban renewal projects the current proposal is to expand the exemption so that it will apply to 2 apartments per seller per building.

• Sale of rights in an urban renewal project between entrepreneurs – according to the current legal situation, double purchase tax is paid on the value of land in an urban renewal project when it is transferred between entrepreneurs. Also, there is a dispute as to whether the rights transferred in such an urban renewal project are indeed rights in real estate. In order to encourage the tradability of urban renewal projects between entrepreneurs for the purpose of completing projects there is a proposal to determine that a right in an urban renewal project will be considered a right in real estate from the time of signing the tenants’ agreement with the entrepreneurs and even before the suspending conditions are met. At the same time, the purchase tax will only be charged once. This means that any transfer of an urban renewal project from one entrepreneur to another will entail deducting the liabilities of the entrepreneur to the tenants from the value of the land. It is clarified that this section will only apply with respect to transactions in which one entrepreneur steps into the shoes of another entrepreneur.

• Taxation of rental income from residential apartments – it is proposed to include several changes in the taxation of rental income from residential apartments as follows:

♦ Owner of a single apartment who rents out the apartment he owns while renting an apartment himself will be able to deduct from his rental income the rental expenses he pays, up to a monthly ceiling of NIS 7,500.

♦ Applying reporting liability on exempt rental income assuming that many landlords benefit from income that is not exempt by law and do not report it for various reasons.

♦ Canceling the linkage of the exemption ceiling on income from renting a residential apartment so that it stands at NIS 5,470 and will not be updated beyond that.

• Encouraging the sale of old land – in order to increase the supply of land for residential purposes, there is a proposed temporary order, valid until December 31, 2026, to grant tax incentives to individuals who own land on which at least 15 housing units can be built. According to current law, the amount of capital gains tax to be paid for the sale of old land that was purchased until November 6, 2001, is calculated linearly – the capital gain allocated to the period until November 6, 2001 is subject to the marginal tax rate (up to 50%) and the capital gain allocated to the period from that day until the day of sale is subject to 20% / 25% tax. This high tax rate creates a negative incentive for the sale of old land and delays the development of land and the increase in the supply of apartments. Therefore, it is proposed to determine, in a temporary order, that in a sale of land intended for residential construction by an individual, until December 31, 2026, a reduced capital gains tax rate of 25% will apply to the portion allocated to the period until November 6, 2001, subject to additional conditions specified in this section. It should be noted that the portion of the capital gain which is entitled to the relieved tax rate will also depend upon the period until the completion of the construction on the land. A land on which construction will not be completed within 96 months from the sale shall not be entitled to capital gain tax relief. This amendment appears in the Government Decisions document but has not yet been included in the legislative memorandum.

It should be mentioned that similar temporary orders existed in the past but have expired.

• Cancellation of linear exemption for new apartments built on old land – currently, the capital gains tax on the sale of an apartment which was purchased prior to January 1, 2014, by individuals who own more than one residential apartment is calculated according to a preferred linear calculation, so that capital gain attributable (linearly) to the period until January 1, 2014 is exempt from capital gains tax, while capital gain attributable to the period from that date onwards is subject to capital gains tax at the rate prescribed by law. This relief is currently also provided to individuals who owned land on which they built residential apartments, with the linear calculation carried out from the date of purchase of the land. It is proposed to amend the law so that it states that the seller of a residential apartment which was built on land that was purchased prior to January 1, 2014 will not be able to enjoy the benefit of the linear calculation unless he issues a permit for the construction of a residential unit by June 30, 2027. This amendment appears in the Government Decisions document but has not yet been included in the legislative memorandum.

• Shell apartments – currently there are apartments that are sold by the contractor without building the interior of the apartment (“Shell Apartments”). This issue leads to controversies regarding the applicability of the definition of “residential apartment” to such apartments, regarding the liability for purchase tax. It is proposed to explicitly state in the law that Shell Apartments will be subject to purchase tax according to the definition of a residential apartment in the real estate taxation law. This amendment appears in the Government Decisions document but has not yet been included in the legislative memorandum.

• Exchange of apartments – in order to prevent apartment owners who exchange one apartment for another, and as part of the purchase and sale process own more than one apartment for a certain period of time, from waiting for housing prices to rise before selling the old apartment, it is proposed to shorten the holding period in which it will be considered as if the seller owns only one apartment, for the purposes of exemption and relief from capital gains and purchase tax. It is proposed that the period be shortened from 24 months to 12 months. This amendment appears in the Government Decisions document but has not yet been included in the legislative memorandum.