How a US LLC's Israeli Rental Assessment Fell from NIS 186,000 to NIS 22,600

Result: An Israel Tax Authority assessment on a Delaware LLC's Tel Aviv rental cut from NIS 186,000 to NIS 22,600, with USD 31,000 of previously unclaimed US foreign tax credits recovered · Timeline: 14 months from audit letter to signed assessment · Challenge: A US LLC cannot use Israel's flat rental track · Authority: Israel Tax Authority (Rashut HaMisim), Tel Aviv assessing office · Financial Impact: NIS 163,400 removed from the demand

Background

Three siblings in New Jersey bought a four-room apartment off Ibn Gvirol in north Tel Aviv in October 2018 for NIS 3,400,000, funded partly by an Israeli mortgage of NIS 1,500,000. Their US attorney did what he does for every American real estate purchase and put the title into a Delaware LLC owned equally by the three of them. Purchase tax at the non-resident rate of 8% came to NIS 272,000, which nobody enjoyed but everybody expected.

The flat was let at NIS 16,500 a month. For five years an Israeli bookkeeper filed annual returns on the flat 10% residential rental track, paying NIS 19,800 a year, NIS 99,000 in total. Nobody in New Jersey had reason to think anything was wrong. In March 2024 the Tel Aviv assessing office opened an audit of the 2019 to 2023 tax years, and the opening letter took a single point: the 10% track is not available to a company, and Israel regards a Delaware LLC as a company.

The demand, once linkage, interest and a deficiency penalty were added, was NIS 186,000.

The Challenge

The assessing officer was right, and there was no version of the argument that saved the 10% track. Section 122 of the Income Tax Ordinance 1961 offers a flat 10% on residential rental income in Israel, and it offers it to an individual (yachid). The Israel Tax Authority treats a US LLC as a foreign corporation, a separate taxpayer, because it is an entity with limited liability, and it does so regardless of how the Internal Revenue Service classifies the same entity. Israeli rental income earned by that corporation falls under Section 126 at the 23% corporate rate. The gap between 10% of gross and 23% of something is where the whole case lived.

Two further points made the file worse before it got better. Section 122(c) denies any deduction for expenses or depreciation to a taxpayer on the 10% track, and it goes further: when the apartment is eventually sold, the maximum depreciation that could have been claimed is added back in computing the betterment tax. Five years of returns had therefore been filed claiming nothing, which meant the assessing officer's opening computation applied 23% to gross rent of NIS 198,000 a year with no offset at all. Separately, the officer raised whether the LLC should have registered as a foreign company with the Registrar of Companies under Section 346 of the Companies Law 1999, which if pursued would have added a registration exercise, annual filings and a discussion about whether the LLC had an Israeli permanent establishment.

The American end of the file had its own quiet problem, and the siblings did not know about it. Their CPA in Newark had never claimed a US foreign tax credit for the Israeli 10% tax. He had looked at a flat levy on gross rent with no deductions, formed the view that it might not qualify as a creditable net income tax under the US foreign tax credit regulations, and left it out rather than claim something he could not defend. Five years of Israeli tax had been paid and never used.

In Practice: Section 122 of the Income Tax Ordinance 1961 restricts the flat 10% residential rental track to individuals, and Section 122(c) bars any deduction for expenses or depreciation while still adding the depreciation back when the property is sold. A US LLC is treated by the Israel Tax Authority (Rashut HaMisim) as a foreign company and taxed under Section 126 at 23%. On gross rent of NIS 198,000 a year the Tel Aviv assessing office opened at NIS 227,700 of tax for five years against NIS 99,000 already paid, and with linkage, interest and penalty the demand reached NIS 186,000. The audit was opened in March 2024 and closed in May 2025.

What We Did

We conceded the 10% point in the first written response, in one paragraph, without argument. That decision shaped everything that followed. An assessing officer who has to fight for an obvious win becomes an assessing officer who examines every other line; one who gets it in week two will usually engage seriously on the lines that are genuinely arguable. What we did instead was reopen the computation. A company taxed under Section 126 is taxed on net income, and five years of returns filed on a gross basis had never claimed a single deductible shekel.

The deductions took four months to assemble from New Jersey. Mortgage interest came from the Israeli lender's annual statements and averaged NIS 62,000 a year over the period. Building insurance, the owner's share of arnona and vaad bayit between tenancies, agent's commission on two re-lettings, and NIS 41,000 of repairs after a burst riser in 2022 were all documented, mostly from the property manager's records rather than the siblings' own. Depreciation was the largest single item and the hardest. Israeli practice allows depreciation on the building component of the cost, not on the land, and the file contained no land and building split. We commissioned a valuer's apportionment, which put the building at 70% of the 2018 cost, giving a depreciable base of NIS 2,380,000 and NIS 47,600 a year. The assessing officer accepted the apportionment prospectively and for 2021 onward but refused to apply it to 2019 and 2020, on the basis that the valuation was retrospective and the earlier years had been filed on a track that excluded depreciation by statute. We did not push it. The disallowance cost about NIS 22,000 of tax and would have cost more than that in time.

The Section 346 question was dealt with by evidence rather than argument. The LLC had no office, no employee and no bank account in Israel beyond the rent collection account, its members had never been Israeli residents, the property manager was an independent contractor engaged on standard terms, and the single apartment was passively let on annual tenancies. That is not a company maintaining a place of business in Israel, and the officer dropped the point at the second meeting. Where a foreign company genuinely does operate here the answer is different, and our case study on an Australian company registering an Israeli branch sets out what that involves.

We also modelled, and then rejected, the obvious structural fix. Moving the apartment out of the LLC and into the siblings' own names would restore the 10% track, but a transfer from a company to its members is a sale within the meaning of Section 1 of the Real Estate Taxation Law 1963. It would trigger betterment tax on the LLC's gain since 2018 and a fresh charge to purchase tax at the non-resident rate on the current value of about NIS 4,600,000, which at 8% is NIS 368,000. Against an annual tax difference now measured in a few thousand shekels, the unwind made no sense. The structure that was wrong to create was not wrong enough to undo, which is a sentence worth reading twice before anyone titles Israeli property to a US entity.

In Practice: The five years closed by an assessment agreement (shuma be'hesken) under Section 145 of the Income Tax Ordinance 1961 at the Tel Aviv assessing office in May 2025, 14 months after the audit letter. Agreed Israeli tax across 2019 to 2023 was NIS 117,300 against NIS 99,000 already paid, leaving NIS 22,600 including linkage and interest, in place of the NIS 186,000 demanded. The LLC now files annually on Form 1214, due by 31 May following the tax year, on a net basis with depreciation claimed each year.

The Outcome

The Israeli demand fell from NIS 186,000 to NIS 22,600. Israeli professional fees for the audit, the valuation and the negotiation came to NIS 39,000, so the siblings were roughly NIS 124,000 better off than if they had paid the opening figure, which was their first instinct and very nearly their decision.

The more interesting recovery happened in the United States, and it happened because of the reclassification rather than in spite of it. Their CPA's doubt about crediting the Israeli 10% levy rested on its character: a flat charge on gross rent, no deductions, no relationship to net gain. Once Israel had assessed the same rental income on a net basis at the corporate rate, with depreciation and interest deducted, that objection disappeared. The LLC is a partnership for US purposes, so its three members are the persons on whom the Israeli tax is regarded as imposed and the persons entitled to credit it. We coordinated a set of amended returns with the Newark CPA in the autumn of 2025.

Timing was the part that could easily have been missed. The ordinary three-year window for a US refund claim had closed on 2019 and 2020. A refund claim attributable to foreign taxes runs on a different clock, ten years from the due date of the return for the year the foreign taxes were paid or accrued under Internal Revenue Code section 6511(d)(3)(A), so every year back to 2019 was still open. The amended filings recovered USD 31,000 of credits that had been sitting unused, most of it from years the siblings had assumed were closed. The Israel Tax Authority and the IRS were, for the first time since 2018, taxing the same income in the hands of the same people.

Israel and the United States have no treaty provision that resolves entity classification, and the mismatch between a US disregarded or pass-through LLC and an Israeli opaque company is a structural feature of holding Israeli assets this way rather than a mistake anyone made in a particular year. Israel Tax Authority Circular 05/2004 addresses one side of it, allowing a member to elect look-through treatment for foreign tax credit purposes, and it is a partial remedy rather than a cure. Our answer on holding an Israeli rental apartment through a US LLC explains why the decision belongs before the purchase, and our guide to the Israeli rental income tax tracks open to non-residents sets out what an individual owner can choose between.

Key Takeaways

What this case illustrates for non-residents in similar situations:

1. Israel's flat 10% rental track is written for individuals and nothing else. Title the apartment to a US LLC, a corporation or a trust company and the rent is taxed under Section 126 at 23%, whatever the IRS thinks the entity is.
2. Losing the 10% track is not automatically expensive. On a leveraged property with real depreciation, 23% of net can land close to 10% of gross, and in this file the difference over five years was NIS 18,300 of tax.
3. Never file five years on a gross basis and then discover you needed the expenses. Keep the mortgage statements, the repair invoices and a land and building apportionment from the year of purchase, because a retrospective valuation will not always be accepted for the earliest years.
4. Concede what cannot be won, and do it early. The 10% point was unarguable, and giving it up in the first letter bought a serious hearing on depreciation, interest and the permanent establishment question.
5. Check whether your US accountant has actually been claiming the Israeli tax. Doubt about whether a gross-basis foreign levy is creditable is reasonable, and the ten-year window in section 6511(d)(3)(A) means that doubt can often be resolved in your favour years later.

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Facing a Similar Situation?

If you hold Israeli property through a US entity and an Israeli assessing officer has questioned the rental track you have been filing on, the outcome usually turns on how much of the last six years of expenditure you can still document.

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