Inheritance division: A tax-exempted operation... with reservations

In Israel, there are no inheritance taxes. Heirs do not pay taxes on their share of inheritance, regardless of its value (at least if they are Israeli residents). But what happens when heirs decide to divide the assets among themselves differently from what was planned by the deceased (if there is a will) or by the law (in the absence of a will)?

This question becomes particularly relevant when the estate consists of multiple real estate properties, and the heirs wish to avoid remaining in joint ownership of one or more properties. In this case, the heirs resort to a partition agreement.

The partition agreement among heirs is governed by Article 5.c.4. of the Real Estate Tax Law - 1963. According to this article, heirs can establish a distribution of assets among themselves, different from the will or the law, without these transactions among heirs being considered taxable transfers for capital gains tax or registration duties.

The law sets two conditions:

(1) The partition must only be between heirs (excluding third parties) as part of the first distribution of the estate.

(2) The partition must involve only the estate assets (excluding external assets or sums).

A recent ruling by the District Court of Tel Aviv (168/20) has reiterated these principles and added some clarifications:

What does the first distribution of the estate mean?

The exemption assumes that the distribution takes place within a short period after the death. Thus, siblings who decide to remain co-owners of two apartments for several years, and then divide these apartments in such a way that each of them receives only one in full ownership, are not eligible for the exemption. Indeed, maintaining joint ownership for several years indicates an agreement among the heirs on an initial distribution of assets. This is especially true when the co-owners share the rents of the two apartments for several years.

The ruling also specifies that the distribution can only concern assets included in the estate. If the agreement provides that one of the heirs will receive a specific asset in exchange for paying a sum to the other heirs (from their own funds), the tax authority will consider it a non-exempt purchase transaction. However, if the concerned heir decides to pay a sum by renouncing his share in the cash funds included in the estate, then the exemption will be granted. The principle is that only elements of the estate are distributed as part of the agreement among heirs.