Bequeathing Assets Overseas to Israeli-Resident Beneficiaries 

By: Arye Leybovich Adv. and Harel Locker Adv.

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Many Jews living in the Diaspora seek to leave property to their Israeli-resident descendants and/or to various different organizations in Israel. Similar to many others, these future benefactors, who are residents of countries such as the United States or the United Kingdom, are interested in memorializing their wishes in a last will and testament.

Quite naturally, for purposes of drafting the will, the above-mentioned foreign benefactors hire the services of local attorneys in their resident countries. Since Israel has no estate tax, these would-be testators and their counselors are unaware of the double taxation danger lurking within the situation described.

What exactly is at issue? The laws of many countries impose an estate tax in connection with certain assets – primarily real estate. When the testator passes away and bequeaths a specific asset to an Israeli beneficiary, the beneficiary will pay an estate tax in the testator’s country of residence with respect to the inheritance on the gain realized up to the date of death.

On the other hand, under Israeli law, a beneficiary inheriting an asset (whether an asset located in or outside of Israel) from a testator dying after 1981, “steps into the shoes” of the testator regarding its acquisition date and cost basis. That is, the cost basis that will be netted against the beneficiary’s selling price and, thus, that will determine his gain, is the testator’s acquisition cost – and not the property’s value on the date of death when it passed to the ownership of the beneficiary. To illustrate, assuming the testator acquired the property in 1970 for $100,000, on the date of death in 2006 the property’s appreciated value was $1,000,000, and thereafter the beneficiary sold the asset for a price of $1,200,000, the beneficiary will pay tax in Israel on a capital gain of $1,100,000 ($1,200,000 – $100,000). In addition, the beneficiary will also pay an estate tax, based on the tax rates in every country imposing such a tax, based on the value of the property on the date of death, i.e., $1,000,000. The result is that the Israeli beneficiary may ultimately pay tax twice on the same gain – once as estate tax in the testator’s country of residence and again in the form of capital gains tax in Israel.

Proper planning of the property disposition during the benefactor’s lifetime can avoid a “tax casualty” such as that described above. In the situation outlined, it is possible to achieve a situation wherein sale of the property by the Israeli beneficiary will not be subject to Israeli tax.

In some cases, the future tax problem can be solved by setting up a trust and giving the trustee specific administration instructions. In other cases, imposition of tax in Israel can be avoided by proper drafting of the will’s disposition provisions along with giving precise instructions to the executor of the estate. There are also cases where steering clear of a future tax payment can be accomplished through including instructions in the will directing distribution of the assets among the various beneficiaries based on the different types of assets involved (cash, real property, personal property, etc.). All of the above strategies are capable of avoiding imposition of a future tax on the Israeli-resident beneficiaries.

It should be noted that a real property asset overseas is not within the ambit of a “real estate right” for purposes of the Real Estate Tax Law, which applies only upon real estate located in Israel. Sale of real property asset overseas by the beneficiary will be subject to tax pursuant to the provisions of the Income Tax Ordinance applying to capital gains. Therefore, there will also be no application of the provisions of Section 5(C) of the Real Estate Tax Law, which provide that sale of a “real estate right” held by an estate executor is tantamount to sale of the right by the beneficiaries. That is, the beneficiaries will pay tax upon sale of the estate’s assets by the executor of the estate. This section puts an end to the rule espoused by a number of judicial decisions whereby, in general, the estate’s executor “stepped into the shoes” of the testator upon his sale of the asset and was entitled to the benefits that the testator would have enjoyed had he sold the asset during his lifetime. However, the old rule, prior to enactment of Section5(C) of the Real Estate Tax Law, may be applied to the sale of a real estate asset overseas that is part of a foreign testator’s estate. With proper tax planning, a situation can be created wherein the executor will be viewed as the seller of the asset on behalf of the testator who then, as it were, will bequeath the proceeds to the Israeli beneficiary.

In summary, foreign residents wishing to leave property to Israeli beneficiaries would be well advised to consider the relevant Israeli tax consequences, even though Israeli law imposes no estate tax, and to do the necessary planning in a timely manner. It should also be noted that while subsequent to the date of death steps can still be taken that will mitigate the tax problem, nonetheless, at that time the available options will be significantly more limited.