Capital Gains Tax on an Apartment Owned by a Company — What Are the Risks?

Introduction: An Apartment in a Company — Why Is It Different from Personal Ownership?

When an apartment is owned by a private company rather than an individual, its sale involves three layers of taxation: capital gains tax, acquisition tax, and income tax. Each layer can lead to substantial payments, and in some cases, to legal pitfalls that few people understand in advance.

Unlike the sale of an apartment in personal ownership, where the calculation is relatively straightforward, corporate ownership creates a situation in which the tax authorities (Israel Tax Authority, Ministry of Interior) can view the transaction as having a business income dimension or a change of use, which affects the determination of tax liabilities.

At Mandelbaum, Gur, Witzman-Gur Law Firm, we have over 18 years of experience handling complex real estate transactions, including the sale of apartments owned by companies. We help our clients identify risks in advance and plan the transaction in a way that minimizes tax expenses.

What Exactly Is Capital Gains Tax?

Capital gains tax is a tax imposed on the profit generated by an increase in the value of a land-based asset (such as an apartment). It is calculated as the difference between the sale price and the "base value" of the asset, determined according to the value of the land on the date of purchase or on a specific date set by law.

When an apartment is owned by a private company, capital gains tax is paid by the company, not by the shareholders. This means the company must pay the tax itself, which directly impacts the profit remaining in the hands of the shareholders after completion of the transaction. Shareholders may also be liable for income tax on dividends or on the difference in the value of shares, creating a second layer of taxation.

Key Tax Risks in the Sale of an Apartment Owned by a Company

• Capital gains tax at full rate: Unlike personal ownership, where certain reliefs exist (such as for primary residences), a company pays capital gains tax at the standard rate (usually 25% on profit, although the rate may vary depending on circumstances).
• Income tax on dividends or difference in share value: When the company distributes the profit to shareholders (typically through dividends), they pay additional income tax on this income. This can reach up to 50% (depending on tax rates in the current period).
• Acquisition tax: When the company purchased the apartment, it likely paid acquisition tax. If the purchase price was lower compared to the sale price, the difference (capital gains) can be substantial.
• Cancellation of rights or additional payments: In certain cases, when the company holds the asset for a short period or under certain circumstances, the Tax Authority may claim that the transaction is a "business transaction" and impose additional payments, or even interest and penalties.

How Is Capital Gains Tax Calculated on an Apartment Owned by a Company?

Calculation of capital gains tax begins with determining the "base value" of the asset. This is typically the value of the land on the date of purchase or on a specific date set by law (for example, January 1 of a certain year). The capital gain is then calculated as the difference between the value of the land on the sale date and the base value.

The basic formula is:

Capital Gains Tax = (Land Value on Sale Date − Base Value) × Capital Gains Tax Rate

However, when it comes to an apartment owned by a company, several factors complicate the calculation:

• The tax rate varies depending on the type of asset, the duration of the company's ownership of the asset, and additional conditions.
• Expenses the company incurred (improvements, repairs, taxes paid) may be deductible from the capital gain, although not in all cases.
• If the company registered rights in the asset, this may affect the calculation of the base value.

Due to this complexity, it is essential to consult with a tax advisor or a real estate lawyer with experience before planning the transaction.

Comparison: Apartment in Personal Ownership vs. Apartment Held by a Company

To understand the risks clearly, it is advisable to compare two scenarios: selling an apartment in personal ownership versus selling an apartment held by a Ltd. company.

As can be seen from the table, corporate ownership of an apartment creates substantially greater tax burden. Additionally, the Tax Authority audits such transactions with higher frequency, which increases the risk of legal audit and additional tax claims.

Additional Legal Risks

Beyond direct taxation issues, there are several additional legal risks to consider:

• In-depth Tax Audit: The Tax Authority may examine the sale price, the terms of the transaction, and payment plans. If it concludes that the transaction is a "tax trap" or that the sale price does not reflect the true value, it may impose additional payments, interest, and penalties.
• Cancellation of Arrangements or Allowances: If the company adjusted the sale price based on certain tax allowances, and those allowances prove invalid, there may be a need to pay additional amounts.
• Issues with Representations and Warranties: In a purchase agreement, the apartment owner (the company) makes representations regarding the legal status of the property. If any of these are inaccurate, the buyer may claim damages.
• Risk of Inheritance or Company Dissolution: If the company dissolves or disappears after the transaction, it may be difficult to enforce payment of capital gains tax or to claim compensation if an issue is later discovered.

How to Reduce Risks? — Legal Planning and Taxation

Although the risks are significant, there are ways to structure the transaction to minimize tax expenses and protect shareholders. Here are some common strategies:

1. Setting the Correct Sale Price

This may seem simple, but setting a sale price that reflects the true value of the property is critical. If the sale price is too low, the tax authorities may suspect a hidden "gift" or unjustified discount. If it is too high, capital gains tax will be higher. The correct approach is to use a professional appraiser who will evaluate the property objectively.

2. Structuring the Transaction

In some cases, instead of selling the apartment directly, alternative structures can be considered, such as:

• Sale of the company's shares (instead of selling the property itself): This may have different tax implications, although it is not always less expensive.
• Liquidation of the company and distribution of the apartment to shareholders: Under certain circumstances, this may be more tax-efficient.
• Transfer of the apartment to another company or to an investment fund under certain conditions.

Each of these structures involves different legal implications, and a thorough analysis is required to determine which is best for the specific situation.

3. Deduction of Expenses

The company may be entitled to deduct certain expenses from the capital gain, such as:

• Costs of improvements made to the property.
• Taxes paid on the property during the company's ownership.
• Legal and administrative costs related to the acquisition or sale.

However, not every expense is deductible, and the laws on this matter are complex. A thorough analysis of each expense by a tax advisor or attorney is required.

4. Planning the Duration of Ownership

In some cases, the length of time the company holds the property may affect the tax rate or eligibility for certain tax relief. If the company holds the property for a long time, special conditions may apply.

5. Settlement with the Tax Authorities

In some cases, it is possible to contact the tax authorities (or have a tax advisor handle this) to check the situation in advance, obtain legal guidance, or even reach a settlement that reduces tax expenses.

What to Do If the Tax Authority Audits the Transaction?

If the Tax Authority has initiated an audit of a transaction involving the sale of an apartment owned by a company, this can be a stressful and worrying situation. However, there are steps you can take to protect your rights:

• Hire a lawyer as soon as possible: If you received a letter from the Tax Authority, do not attempt to handle it alone. A lawyer with experience in real estate and tax law can guide you through the process.
• Gather all relevant documents: Property deed, purchase agreement, appraisal report, tax declarations, all correspondence with the Tax Authority, and any other documents related to the transaction.
• Do not communicate with the Tax Authority without legal counsel: Anything you say may be used against you. It is always preferable that a lawyer or tax consultant participate in such conversations.
• Consider a settlement: In some cases, it is possible to reach a settlement with the Tax Authority that reduces the amount you need to pay or extends the payment period.

Summary: The Risks and Methods of Protection

Selling an apartment owned by a private company involves substantial risks:

• Full capital gains tax (without relief) at a rate of 25% on the profit.
• Additional income tax on dividends at a rate of up to 50%.
• High risk of tax audit compared to personal ownership.
• Additional legal risks: Cancellation of benefits, tax claims, issues with contract representations.

However, risks can be reduced through proper legal and tax planning:

• Setting the correct sale price based on a professional appraisal.
• Planning the structure of the transaction (direct sale, share sale, company liquidation, etc.).
• Deducting valid expenses from the capital gains.
• Conducting a thorough legal review of the property and transaction.
• Engaging with the Tax Authority in advance to review the situation.

Mandelbaum, Gor, Witzman-Gor & Co., Attorneys at Law, can assist you at every stage of this process. We have over 18 years of experience in complex real estate transactions, and we are able to structure the transaction in a way that protects your rights and minimizes tax costs. First consultation meeting at no cost to discuss your transaction.