Don't fall into this trap. In Israel, it's common for young couples to buy an apartment and rent it out for a few years.

Don't fall into this trap. In Israel, it's common for young couples to buy an apartment and rent it out for a few years. Often, it's a small apartment or far from their place of residence, in a cheaper locale.

They then sell it, and then use the capital gains and their savings as a springboard to buy a full size apartment in a preferred location.

There are no Israeli taxes due in such a case; Israeli law allows a full exemption from capital gains taxes if it's their only apartment.

Sounds great, right?

They fell in the trap. US citizens must pay capital gains taxes to the US on investment apartments sold, even if it's the couple's only property. 

Many people only realize this long after they have already used all the gains from the first apartment to buy a new one to actually live in. 

I recently spoke to two separate people who each owe the IRS about $100k in taxes, with barely anything left in their bank accounts after the new apartment purchase!

For US citizens, essential tax planning is required in order to either avoid this, or to have a tax estimation done to make sure to simply put enough funds aside for US taxes.

Here are a few options:

1) Set aside funds to pay the taxes, and do not use them to buy a new apartment! 

This is the simplest and most practical solution, and may make sense in many cases. But full taxes will have to be paid.

A payment agreement with the IRS, or even better, a partial payment agreement may be great options.

2) Go live in the original apartment for at least 2 years, and claim the primary residence exclusion of capital gains, up to $500k for a married couple. 

Those with non US citizen spouses may also do this through a 6013(g) election. 

This may not be so practical though, since normally this first apartment may be much too small for a growing family, too far from their regular place of residence and the move would upend their life, or both.

3) Arrange a 1031 like-kind exchange through an authorized agent. 1031 exchanges allow deferment of payment of capital gains taxes until the sale of the home. 

The second apartment must be rented out for at least two years, after which the couple would qualify for the primary residence capital gains exclusion of $500k if they were ever to sell it, just like a regular residence. However, the gains allocable to the two years it was rented out cannot be excluded.

The family can rent a different apartment to live in while they rent out their new apartment. If it's in the same locale, and similar size, the rent received may cancel out the rent they need to pay, without much loss. Taxes on rents received should be negligible vs. paying full capital gains tax on the first apartment. 

After two years, they may move in to the new apartment without triggering any capital gains taxes for the old apartment. 

This may be the most practical and tax-saving solution in some cases, but it needs to be done carefully in order to avoid triggering any taxes.