Capitalization of Leasehold Rights in Israel — Complete Legal Guide

What is Capitalization of Leasehold Rights in Israel?

Capitalization of leasehold rights is a legal process that allows a leaseholder (tenant) to acquire ownership of their apartment from the Israel Land Authority (ILA) or from previous owners, utilizing the legal rights accumulated over years of leasehold. This process is particularly essential for apartments in urban renewal projects and for tenants holding long-term leases.

When dealing with leasehold rights from the Israel Land Authority, the leaseholder holds a leasehold right that has legal validity and economic value. Capitalizing these rights means converting the leasehold right into full ownership (or a renewed lease under different conditions), with the leaseholder paying capitalization fees determined according to a specific legal formula.

Why Do Leaseholders Choose Capitalization?

• Full Ownership: Instead of remaining a leaseholder, the tenant becomes the property owner.
• Economic Value: Full ownership increases the property's market value in real estate.
• Preservation of Rights: For an expired or expiring lease, capitalization is a legal way to preserve rights.
• Mortgage Improvement: Banks prefer lending on fully owned property rather than leasehold.
• Future Planning: Full ownership enables inheritance and succession without time limitations.

Discussion of capitalization of leasehold rights is one of the most important topics in real property law in Israel, particularly in the context of urban renewal projects and existing residents in existing housing.

Capitalization Fees — How They Are Calculated and What They Include

Capitalization fees are the consideration paid by the leaseholder to the Israel Land Authority (or to previous owners, depending on the arrangement) to obtain full ownership of the property. Calculation of capitalization fees is based on a legal formula established by Israeli case law and legislation.

Factors Affecting Capitalization Fees

• Property Market Value: The higher the apartment's value, the higher the capitalization fees.
• Remaining Lease Period: A lease with a longer remaining period results in lower capitalization fees.
• Leaseholder's Years of Ownership: A leaseholder who has occupied the property for many years may be entitled to reductions or benefits in capitalization fees.
• Property Condition: A well-maintained property may require higher capitalization fees.
• Geographic Location: Properties in strong neighborhoods or with high demand will have higher capitalization fees.

Composition of Acquisition Costs in the Capitalization Process

In addition to the capitalization fees themselves, the leaseholder should be aware of additional costs included in the acquisition process:

• Capital Gains Tax: When the property increases in value as a result of capitalization, capital gains tax applies to the difference between the previous and new value. The rate varies depending on the holding period and property type.
• Acquisition Tax: When registering the property under the leaseholder's name, acquisition tax may be due according to the rates in effect in the year of acquisition.
• Land Registry Registration Fees: Registration costs at the Israel Land Registry under the new leaseholder's name.
• Attorney Fees: Legal costs for guiding the process.
• Inspections and Appraisals: Legal inspections, property valuations, capital gains tax reports.

These costs can amount to a substantial sum, making it essential to plan ahead and obtain professional legal advice before beginning the process.

Typical Scenarios and Examples

To better understand how the process of redeeming lease rights works in practice, here are several typical scenarios we encounter in our work:

Scenario 1: A Tenant in an Apartment in an Urban Renewal Project

A tenant has been living in an apartment in an urban renewal project (TAMA 38) for about three years. The apartment was purchased for 1.5 million shekels. Currently, the apartment's market value stands at approximately 1.8 million shekels. The tenant wishes to purchase full ownership. The redemption fees will be calculated based on the difference between the current value and the previous value, taking into account the remaining lease term. Additionally, a capital gains tax on the profit of approximately 300,000 shekels will be required, as well as registration fees and legal fees.

Scenario 2: A Lessee in a Long-Term Lease Nearing Expiration

A lessee rents an apartment from the Israel Lands Authority (RMLI) for 49 years, and the lease is set to expire in three years. The property has significant value, but without full ownership, it is difficult to transfer or leave as an inheritance. The lessee decides to redeem his rights before the lease expires. In this scenario, the redemption fees may be lower because the remaining period is short, but redemption is the right step to salvage the property and pass it on to heirs in better conditions.

Scenario 3: Apartment Owners in Existing Housing Seeking Redemption

Owners of apartments in existing housing (not TAMA 38) who lease from the Israel Lands Authority or from previous owners decide to redeem their rights in order to improve their mortgage conditions, increase the property's value, or facilitate inheritance. In these scenarios, there may be legal benefits or discounts depending on the lease term and the legal status of the property.

Scenario 4: Negotiating Redemption Fees

A lessee receives an initial offer for redemption fees higher than expected. He contacts a law firm to review the offer and conduct negotiations with the other party. With the help of legal and economic analysis, it is sometimes possible to reduce the redemption fees or achieve better payment terms.

The Process of Redeeming Lease Rights — Main Steps

The process of redeeming lease rights is complex and requires careful legal guidance. Below is a description of the main stages:

Step 1: Initial Legal Review

At this stage, the attorney examines the lease status: who is the current owner, what is the lease term, are there legal restrictions, and what are the redemption conditions under law or in the original agreement. This review is critical to understand whether redemption is possible and what the expected costs are.

Step 2: Property Valuation

To calculate redemption fees, the property must be valued at current market rates. Typically, a professional appraisal by a real estate appraiser or team of experts is requested. This value will serve as the basis for calculating redemption fees and capital gains tax.

Step 3: Calculation of Redemption Fees and Taxes

Based on the estimated value, redemption fees are calculated according to the legal formula. Additionally, expected capital gains tax and purchase tax are calculated. The attorney presents the lessee with a detailed table of all costs.

Step 4: Negotiation (if necessary)

If the offered redemption fees seem high or if there are questions regarding the rights or conditions, negotiations can be conducted with the other party (Israel Lands Authority, previous owners, or other legal successors). Such negotiations can be lengthy but may result in better outcomes for the lessee.

Step 5: Preparation of Documents and Agreements

After agreement on redemption fees and other conditions, the necessary legal agreements are prepared. These documents include: a redemption agreement, a request for registration in the land registry, inquiries with tax authorities, and other required documentation.

Step 6: Payment Execution

The lessee pays the redemption fees (sometimes in installments, according to the agreement). Payment is typically made through an attorney or a trust account to ensure transparency and legality.

Step 7: Registration in the Land Registry

After payment is made and all documents are signed, a request is filed to register the property in the name of the new lessee at the land registry office. Typically, this process takes several weeks to several months, depending on the workload of the authority and the response of additional parties.

Step 8: Completion and Legal Settlement

After the property is registered in the land registry, the process is complete. The lessee is now the full owner of the property and can use it freely — to sell, leave as an inheritance, or use as collateral for a loan.