Capital Gains Tax on Israeli Investments for US Residents

A client in New Jersey inherited a brokerage account in Tel Aviv from his father and assumed the worst: that selling the Israeli shares inside it would trigger a 25% Israeli tax bill on top of whatever the IRS wanted. He was relieved, then confused, when I told him Israel would probably take nothing at all. The American tax exposure, on the other hand, was the part he had not thought about.

That reversal is the recurring story for US residents holding Israeli investments. Israel, contrary to expectation, exempts most non-residents from capital gains tax on Israeli securities. The United States, contrary to expectation, often imposes more, especially where Israeli funds are involved. Understanding which gains Israel actually taxes, and where the real cost lands, is what separates a clean sale from an expensive surprise filed two countries apart.

When Israel Taxes a Capital Gain at All

The starting point is the source rule. Section 89(b) of the Income Tax Ordinance 1961 treats a capital gain as Israeli-source if it arises from an asset located in Israel, including shares or rights in an Israel-resident company. So a gain on Tel Aviv–listed shares or in a private Israeli company is, on its face, within Israel's taxing reach.

What pulls most US residents back out of that reach is a deliberate set of exemptions Israel created to attract foreign capital.

For securities traded on the Tel Aviv Stock Exchange, a non-resident is generally exempt from Israeli capital gains tax, provided the gain is not connected to a permanent establishment in Israel. For private (unlisted) Israeli company shares, an exemption applies to non-residents on shares acquired after 1 January 2009, again subject to conditions. The most important condition for both: the company must not be, in substance, a real estate company. If the main value of the company's assets derives from Israeli real estate, the exemption falls away and Israel taxes the gain.

In Practice: Under Section 97(b3) of the Income Tax Ordinance 1961, a non-resident is exempt from Israeli capital gains tax on shares of an Israeli company purchased on or after 1 January 2009, unless the company's value derives principally from Israeli real estate. The Israel Tax Authority (Rashut HaMasim) administers the exemption, but Israeli brokers still apply default withholding of 25% at the point of sale; recovering wrongly withheld tax through a refund claim typically takes 4–9 months from filing. Establish the exemption with your broker before you sell, not after.

The Rates That Apply When No Exemption Is Available

Sometimes the exemption does not reach. A pre-2009 private shareholding, a real estate–heavy company, or a gain effectively connected to Israeli business activity can all bring Israel back into the picture.

When Israel does tax the gain, the rates for individuals are:

• 25% on the real (inflation-adjusted) gain for an ordinary shareholder
• 30% where you held 10% or more of the company at the date of sale or at any point in the preceding 12 months — the "substantial shareholder" rate
• A 3% surtax (mas yesef) can apply on top at high total-income levels

The word "real" matters. Israel taxes the inflation-adjusted gain, not the nominal one, so the shekel cost basis is indexed before the tax is computed. For a US resident this creates a mismatch worth flagging: the IRS measures your gain in dollars from your dollar basis, while Israel measures a different, inflation-adjusted figure in shekels. The two numbers rarely match, and the foreign exchange movement between purchase and sale can make the dollar gain and the shekel gain point in opposite directions.

The American Side Is Where the Cost Usually Lands

Here is the part my New Jersey client had not considered. A US resident — whether a US citizen, a green card holder, or a US tax resident — is taxed by the IRS on worldwide capital gains regardless of what Israel does. An Israeli exemption does not remove the US tax. It simply means there is no Israeli tax to credit against it.

Ordinary Israeli shares held long term are taxed in the US at the usual long-term capital gains rates and reported on your Form 1040, Schedule D. So far, unremarkable.

The trap is Israeli funds. Most Israeli mutual funds (kranot ne'emanut) and Israeli exchange-traded funds (kranot sal) are, in IRS terms, Passive Foreign Investment Companies. PFIC treatment under the US Internal Revenue Code is punitive: gains can be taxed at the highest ordinary rates with an interest charge for deferral, and each holding generally requires an annual Form 8621. A US resident who buys an Israeli S&P 500 tracker through a Tel Aviv broker has, often unknowingly, created a PFIC reporting obligation that a US-domiciled equivalent would have avoided entirely.

Common Mistake: US residents reinvest Israeli dividend income or inherited cash into local Israeli mutual funds or ETFs because an Israeli banker recommended them, not realising these are PFICs for US purposes. The result is years of Form 8621 filings, ordinary-income tax rates on what should be capital gains, and an interest charge on deferred gain. Untangling a multi-year PFIC position commonly costs US$2,000–6,000 in specialist US accounting fees and can wipe out the Israeli exemption's benefit several times over.

How the US–Israel Treaty Allocates the Gain

The 1975 US–Israel income tax treaty sits over all of this. Its capital gains article generally assigns the right to tax a gain to the country where the seller resides, with carve-outs that matter.

For a US resident selling Israeli securities, the treaty reinforces what Israeli domestic law already grants: the gain is primarily a US matter. The carve-outs to watch are real property and permanent establishments. A gain on Israeli real estate — or on shares in a company whose value is principally Israeli real estate — remains taxable in Israel under the treaty, which is the same boundary the domestic exemption draws. If you do owe Israeli tax on a gain that is also taxed by the US, the treaty and the US foreign tax credit rules under Form 1116 are what prevent the same gain being fully taxed twice.

One practical caution for US citizens specifically: the treaty's "saving clause" lets the US continue to tax its citizens largely as if the treaty did not exist, so a US citizen cannot use the treaty to escape US tax on an Israeli gain. The treaty protects you from double taxation, not from US taxation.

Reporting, Withholding, and Doing This from Abroad

Because you are managing all of this from the United States, the mechanics deserve attention.

On the Israeli side, the broker or bank generally withholds at source when you sell. Establishing your non-resident exemption usually means filing the right declaration with the institution, supported by evidence of US residency, ideally before the transaction. If tax is over-withheld, you reclaim it from the Israel Tax Authority — a process run in Hebrew, often requiring an Israeli representative to file on your behalf under a power of attorney, since you cannot walk into the local tax office from New Jersey.

On the US side, you report the gain on Schedule D, convert shekel figures to dollars using the appropriate exchange rates, file Form 8621 for any PFIC holdings, and claim a foreign tax credit on Form 1116 for any Israeli tax that was genuinely due. Where the account itself is Israeli, FBAR and FATCA reporting obligations run in parallel and are entirely separate from the capital gains question.

The coordination problem is real. An Israeli accountant optimising your Israeli position and a US CPA optimising your US position will not, left alone, talk to each other — and the PFIC issue in particular is invisible from the Israeli side. Someone has to hold both halves at once.

Practical Checklist

• Confirm whether your Israeli shares qualify for the non-resident exemption before selling
• Check whether the underlying company is real estate–heavy, which removes the exemption
• File your non-resident declaration with the Israeli broker to prevent default 25% withholding
• Identify any Israeli mutual funds or ETFs you hold and assess their PFIC status with a US CPA
• Keep shekel purchase records and exchange rates for both Israeli indexing and US dollar basis
• Coordinate Israeli and US filings so a foreign tax credit is claimed only where Israeli tax was actually due
• Use an Israeli representative under power of attorney to handle any refund claim with the Tax Authority

Speak With an Israeli Attorney

Whether you owe Israeli capital gains tax on an Israeli investment, and how to keep an Israeli broker from withholding tax you do not owe, turns on details most US advisers never see — the company's asset mix, your acquisition date, and your non-resident status. An Israeli attorney can confirm your exemption, file the declarations that stop or recover Israeli withholding, and coordinate with your US CPA so the PFIC and treaty pieces line up.

Contact us for a confidential initial consultation.