In the article titled “Tax Optimization for Freelancers Working from Home" we have already looked at what expenses of a freelancer can be recognized by tax authorities as a business expense. In this material, we propose to analyze in more detail whether the costs of renting a residential apartment can be recognized, as well as the recognized costs of a personal apartment, for business operators with a home office.
Withholding tax on rented commercial immovable property
Let’s start with a small rundown on the topic, which is very important for understanding the whole issue of recognizing real estate costs. Read more about what withholding tax is (Nikui mas be makor), here.
So, in accordance with the law, every tenant who pays rent and wants to claim it as a business expense must withhold tax regardless of the volume of activities or turnover.
For example, a businessman rents a store, a plot of land, a warehouse, a conference room, etc. This is also true for a one-time or long-term lease.
You can reduce the tax rate if the leaseholder issues a document concerning exemption or reduction in the withholding tax rate from the income tax authority. But if there is no such certificate, then the tenant is obliged to deduct and transfer to the tax authority the maximum withholding rate in this area of activity, 35% percent of taxes.
In the event that the business is run from a rented apartment and the business owner pays to the landlord on a monthly basis, as with any other expense for the rent to be considered a recognized expense the landlord must treat the lease as income from commercial real property and pay the appropriate income tax on that income.
In most cases, the rent of a dwelling unit is tax-exempt and the landlord will not be interested in paying the income tax on commercial housing. In addition, there is usually a clause in the rental agreement that the apartment will only be used for residential purposes and not for business.
To be able to recognize expenses in case of renting a residential apartment:
It is necessary to change the purpose of the apartment or its corresponding part related to business with the municipality from a residential apartment to commercial real estate and pay the municipal real estate tax (arnona), which is about three times more for commercial real estate.
You need a certificate from the landlord about the exemption or reduction of the tax withholding rate from the income tax authority, which he cannot give, because usually does not pay tax on the lease of residential real estate.
What conclusions can be drawn from all of the above? It is possible to do business from a rented apartment, but it is impossible even to partially recognize payments for the rent of a residential apartment as business expenses.
Recognition of expenses related to a personal apartment
The situation looks quite different if the entrepreneur’s office is located in a private apartment.
It is possible to recognize the depreciation expense of an apartment in the amount of 4% of the cost of the apartment minus the value of the land on which the apartment is built, usually a third of the total cost of the apartment relates to the value of the land. The remaining two-thirds of the cost of an apartment, which is a dwelling without land, must be multiplied by 4% percent and by the relative share of commercial space. Usually this is no more than 25% percent. For example, if an apartment was bought for one million shekels, and we recognize 25% of the cost, then the annual depreciation will be one million shekels, multiplied by two-thirds, multiplied by 4% percent, and multiplied by 25% percent. As a result, we get 6667 shekels of recognized expenses per year for amortization of the apartment owned by the entrepreneur.
If, in order to buy an apartment, the business operator took a long-term mortgage (mashkanta), then it is possible to recognize the interest accrued by the bank on the loan, multiplied by the relative part of the commercial property. That is, if in a given year the interest expense was NIS 10,000 and we recognize 25% of the household’s mixed expenses, then the recognized interest expense is NIS 2,500.
When selling an apartment and calculating capital gains from the sale of the apartment, interest paid on a mortgage may be a recognized expense.
It is important here to make sure that the recognition of these costs does not change the classification of a residential apartment into commercial property. Therefore, it is not worth recognizing too high a percentage (more than 25%) of commercial real estate, so that later the owner is not denied all tax benefits for the sale of a residential apartment.
Moreover, if you are greedy, you can get more problems than benefits. In the case of an overestimated proportion of commercial real estate to residential real estate, the income tax and real estate tax authorities may not recognize some interest expense as a recognized expense for the reduction of capital gains tax.
As long as we have already touched on the topic of mortgages, it is worth noting that if an entrepreneur took out a loan for commercial purposes, and it can be proved that this loan was taken only for business purposes, then the interest on this loan is fully taken into account as a business expense.
An apartment is not an office. Therefore, experienced accountants advise to take a separate office at the earliest opportunity. A clearcut separation of personal life from the business forms a more serious attitude to business both with the business operator and among the clients.