VAT Exemption on the Sale of Residential Apartments in a Mixed-Use Building: The I.P.F. Ruling

The Tel Aviv District Court ruled on January 16, 2017, that the sale of residential apartments in a building that also included commercial units was exempt from VAT under Section 31(4) of the Value Added Tax Law. The reason: at the time of purchase, the company was not entitled to deduct input tax on the apartments, as they were used for residential rental — an exempt transaction. Adv. Shlomi Vaknin represented I.P.F.

• Tel Aviv-Jaffa District Court, Hon. Judge H. Kirsh.

• Result: The appeal was granted.

• Full Judgment (PDF)

I.P.F. operates in real estate. In 2006, it purchased from private individuals the majority of the rights in a building on Ben Attar Street in Tel Aviv, which included rented residential apartments and commercial units. In 2009, it sold its rights, and possession was delivered to the buyers in 2012.

There is no dispute that the sale of the commercial units is subject to VAT. Regarding the residential apartments, the VAT Director assessed the company under Section 5(b) of the Law, since the property was purchased from private individuals and sold to private individuals. The company argued that the sale was exempt under Section 31(4).

Section 31(4) exempts from VAT the sale of an asset for which, by law, input tax on its acquisition could not have been deducted. The Director argued that the company could have deducted input tax on the purchase, as its intention was to evacuate the tenants, demolish the building, and construct a new one.

The Court examined the actual use. The company collected rent on the apartments for approximately six years, until possession was delivered in 2012, and even renewed or extended some of the lease agreements. Such use is neither temporary nor incidental. The Court noted that Tax Ruling 8/11 issued by the Israel Tax Authority also limits temporary use in an exempt transaction to two years. Accordingly, the company was not entitled to deduct input tax on the apartments, and their sale is exempt.

The exemption reflects the symmetry principle: whoever could not deduct input tax on acquisition is not liable for tax on the sale. A real estate dealer holding rented residential apartments may benefit from an exemption on their sale, provided it can be shown that the primary use was in an exempt transaction.

In a mixed-use building, the commercial portion and the residential portion are each examined according to its actual use. A related issue — the sale of rights in a property subject to protected tenancy — was discussed in the Kargad ruling. For assistance with such transactions: Taxation of Complex Real Estate Transactions. VAT exemptions on real estate sales are summarized on the page VAT in Real Estate Transactions and Urban Renewal.

1. When purchasing a mixed-use building, separate the commercial portion from the residential portion already in the contract and in your tax reporting.

2. Document the use of the apartments throughout the holding period: lease agreements, renewals, and rental income.

3. If you deducted input tax on the apartments at the time of purchase, the exemption under Section 31(4) will not apply in the same manner. Verify this before the sale, and obtain a legal opinion if there is any doubt.