Real Estate Association Taxation

A real estate association (igud mekarkein) is a company or other entity whose entire assets, directly or indirectly, consist of rights in real estate (Section 1 of the Land Taxation Law). The sale of shares in such an association constitutes a "transaction in an association," and it is taxed like a sale of the property itself: the seller pays betterment tax (mas shevach) rather than capital gains tax, and the buyer pays purchase tax based on the buyer's proportionate share of the company's real estate assets. Each party must file a report within 30 days.

Send us the company's balance sheet and the draft agreement, and we will determine whether the company qualifies as a real estate association and what the tax implications of the transaction are.

• You are selling or buying shares in a company that holds a building, land, or apartments, and it is unclear whether it qualifies as a real estate association.

• The company also holds cash, securities, or equipment, and you want to know whether these affect its classification.

• You are a substantial shareholder selling shares and want to calculate the betterment tax at a rate of up to 30%.

• The company intends to issue new shares to an investor, and the investor wants to know how much purchase tax will be owed.

• The shareholders are considering dissolving the company and transferring the property to themselves under Section 71.

• A company and its shareholders jointly purchased real estate and allocated future building rights among themselves.

The Land Taxation Law taxes the sale of shares in a real estate association like the sale of the property itself, so the first question is whether the company qualifies as a real estate association.

When Does a Company Qualify as a Real Estate Association

An entity qualifies as a real estate association only when all of its assets, directly or indirectly, consist of rights in real estate. For the purposes of this determination, the following are excluded: cash, shares, bonds, other securities, and movable property that do not serve the association in generating its income, or that the Director considers ancillary to its activities. A company whose shares are listed for trading on a stock exchange is not a real estate association (Section 1).

Betterment Tax on the Sale of Shares

• An individual pays betterment tax of up to 25% on the real gain (Section 48A(b)(1)).

• A substantial shareholder in the association—at the time of sale or during the 12 months preceding it—pays up to 30% (Section 48A(b)(1A)). A substantial shareholder is one who holds at least 10% of any of the means of control in the company, alone or together with another person (Section 88 of the Ordinance).

• A company that sells shares in an association pays tax at the corporate tax rate (Section 48A(a)).

• A high-income individual also pays surtax: 3% on taxable income exceeding NIS 721,560, plus an additional 2% on income from capital sources above the same threshold (Section 121B of the Ordinance).

Purchase Tax on Shares

The buyer pays purchase tax as if purchasing their proportionate share of all the real estate rights held by the association; accordingly, the rate is determined by the type of property (Section 9(b)(1)). The proportionate share is the ratio of the shares sold to the total rights in the association. Where the rights sold confer only an entitlement to assets upon dissolution, the calculation is based on the higher of the two ratios (Section 9(b)(1A)). For purchase tax purposes, the issuance of new shares is also subject to tax, unlike the general definition of a "transaction in an association" under Section 1.

The seller and the buyer must each file a declaration within 30 days of the transaction date. The seller's declaration must be accompanied by the association's balance sheet as of the end of the preceding year, if the association is required to prepare one (Section 73(b) and (c)).

Dissolution Under Section 71

The transfer of property from the association to its shareholders in the course of dissolution is exempt from betterment tax, provided all the conditions of Section 71(a) are met:

• The transfer is made in the course of dissolution, without consideration, and to each shareholder in proportion to their share in the association.

• The designation of the property has not been changed to business inventory.

• In the four years preceding the dissolution, there was no preferential allocation in the association—meaning an allocation that changed the shareholders' rights by 10% or more—and the association did not acquire the property during those years.

In the dissolution of an association that became a real estate association on or after November 7, 2001, Section 93 of the Income Tax Ordinance applies instead (Section 71(b)). Even when the exemption applies, the shareholder is liable for a special tax on the "additional profit" at the dividend tax rate, payable either at the time of transfer (if the shareholder so elects) or upon the sale of the property (Section 71A). An exemption from purchase tax upon dissolution is available only in limited circumstances (Regulation 27(b) of the Purchase Tax Regulations).

1. You send us the company's most recent balance sheets, the shareholder register, and the draft agreement.

2. We examine whether the company qualifies as a real estate association based on its actual assets, and identify which shareholders are substantial shareholders.

3. We calculate the seller's betterment tax and the buyer's purchase tax, and compare the tax implications of a share sale versus a direct sale of the property. In each scenario, we also analyze the VAT implications.

4. In a dissolution, we review the conditions of Section 71, calculate the tax on the additional profit under Section 71A, and advise on the payment timing you choose.

5. We file the declarations within 30 days. If an assessment is issued that you disagree with, we proceed with an objection and an appeal.

This case examined whether the allocation of rights between a company and its shareholders constitutes a transaction subject to VAT.

A.Tz.Y. Mekarkein (Yochman): Tax Appeal 68651-05-22 (May 9, 2024)

A.Tz.Y. Mekarkein and its shareholders, the Yochman couple, jointly purchased real estate from the Israel Land Authority in the Baka neighborhood of Jerusalem. An agreement signed between them prior to the purchase specified how the rights and payments would be divided, and stipulated that all future building rights—including those arising from TAMA plans—would belong to the shareholders. The VAT Director argued that the discrepancy between the allocation of payments for the land and the allocation of construction costs indicated an additional transaction in which the company sold part of its rights to the shareholders, and assessed the company for VAT accordingly.

The Tel Aviv District Court held that under the pre-purchase agreement no such sale had occurred, and that the specification and division of jointly purchased real estate do not constitute a transaction under the VAT Law. The court further held that even if a transaction had taken place, the assessment period for the tax liability had expired. Globes reported that a NIS 1.5 million assessment was annulled and that the company was awarded NIS 95,000 in costs. Adv. Shlomi Vaknin and Adv. Ariel Epstein represented the company. The A.Tz.Y. Mekarkein ruling · The Globes article.

The takeaway for similar transactions: the allocation of rights between the company and its shareholders should be set out in writing before the purchase.

The transaction review, declarations, and objections are led by Adv. Ariel Epstein, a partner at the firm and head of the real estate taxation practice. He completed his internship at the Legal Bureau of the Customs and VAT Division at the Israel Tax Authority headquarters. When a transaction involves a VAT aspect, as in the A.Tz.Y. Mekarkein case, he is joined by Adv. and CPA Shlomi Vaknin, formerly a national supervisor in the Professional Division of the VAT Department.