A real estate option grants the buyer the right to purchase a real estate right under some conditions.
In the past, granting a real estate option was considered a “sale”, and therefore the writer of the option was obligated to pay tax whether the option was executed or not.
In 2002 the 50th Amendment entered into force following the recommendations of the Rabinovich commission. According to this amendment, options which fulfill the conditions of the amendment will enjoy a tax exemption.
Some of the conditions are: the option must be agreed in writing, the option has to be passable, the option period should be limited to twenty four months, the seller obligation to sale the right has to be irrevocable, etc.
In many cases, option agreement is very popular in Israel and acceptable because it allows some commercial flexibility for the option receiver that might be the buyer or the one who traded the option.
As mentioned above, an option agreement can be exempted of tax payment. However, the tax authority can declare that the agreement is actually a sales agreement and therefore it is not exempted of tax payment.
In the case of D.D Lia Initiating and Investments Ltd. V. the Administration of Real Estate Taxation, the main question was whether an agreement between two parties was a specific option agreement which is exempted of tax payment, or a sale agreement which is subject to tax payment.
The appellants were two entrepreneur companies which signed an option agreement with the owners of the rights of the real estate. According to the agreement, the companies received an option to buy the rights from the owners. In addition, it was agreed that the companies can execute the option only if they will manage to vacate the statutory tenants within the option period. After a while, it was agreed that the statutory tenants will receive compensation in exchange for their vacation. Furthermore, the companies signed an agreement to trade the option with an acquisition group which was organized by the companies and the owners. As part of the payment, the acquisition group paid the companies organization fees. After signing the trading agreement the acquisition group executed the option.
The administration of real estate taxation decided to tax the agreement as a sale agreement. The main claim was that the companies bought the land from the owners and afterwards sold it to the acquisition group. Therefore, the companies must pay both capital gains tax and acquisition tax.
As a matter of fact the administration of real estate taxation argued that the agreement should be tested according to its financial essence. In this case, the companies tried to determine in advance the outcome of the agreement.
Contrary to these claims, the appellants argued that it is not a sales agreement and the option fulfills all the conditions stated in clause 49(10) to the real estate taxation law, which provides an exemption from tax payment. To their opinion, the companies are not obligated according to the agreement to execute the option.
The court ruled that in this case the option agreement was actually a letter of agreement that was agreed before the signing of a full sales agreement. Therefore, the option does not fulfill the conditions in clause 49 and there is no exemption from tax payment. This decision was based on the fact that the agreement was worded like it is anticipating future events.
In other words, the agreement grants a free choice for the companies, but its essence raises doubt regarding the actual possibility to execute the option anytime they want within the option period. As a matter of fact, the companies were obligated to execute the option when the statutory tenants vacated the stores.
Clause 49(12) to the real estate taxation law exempt the sale of an option from tax payment if the conditions in clause 49(11) are fulfilled. This option is called “Unique Option”.
Even when all the conditions are fulfilled, the administration of real estate taxation has the authority to decide not to exempt the agreement from tax payment. As mentioned above, the court supports this authority and therefore the discussion involves interpretation.
It is very important to view all the terms in advance and to consider carefully the wording of the agreement in order to avoid a great financial loss.
Our recommendation for our clients who has a real estate option, or for entrepreneurs who are interested in purchasing one is unequivocal – to receive a professional consulting, in order to use the option wisely and enjoy taxation advantages.
In the recent years we accompanied many business transactions from this nature. We learned their complexity, risks and how to deal with problems or to avoid them in advance.
