April 2023
The intent of this increased tax is to raise money for affordable housing and rent assistance. However, Chris and Brian agree this tax law may potentially increase rent; by discouraging development in the City of Los Angeles, fewer new residences will be available to meet rental demand, leading to an increase in rental prices. Furthermore, if buyers of rental real estate bear part of the increased costs (as sellers may require), those costs may ultimately pass through to the tenants as increased rent.
Brian recommends listeners to wait and see how Measure ULA plays out before trying to execute tax-saving strategies. Some people have been considering selling their property in increments, but Brian says strategies like this may not work since Los Angeles may still recognize it as one whole property.
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Hello, everybody, and thank you for joining us for another episode of The Financial Commute. I'm your host, Chris Galeski, joined by wealth planner and estate attorney, Brian Standing. Brian, thank you for joining us.
You're welcome. I came back.
I know. I'm actually really glad that you came back because over the last month or so, I've had a couple of client situations that deal with this new mansion tax, and there's some concerns about that. And I thought that we should educate our listeners on first, like, what is the purpose? Like, what is this mansion tax or Measure ULA that people are talking about?
Yeah, we can talk about that. I feel like every time I come on, it's when it's something that maybe negatively impacts our clients. One of these times we can have like a positive law that clients are going to be pumped about, do I get to come on and talk about that?
I would love that. I hope that there are laws like that are better for our clients.
They usually are, right?
They usually are not in favor.
So yeah effectively the mansion tax is kind of a misrepresentation of what it really is. It may capture the sale of mansions, but really it's just a tax on the sale. So not a gift. And other transfers we'll talk about, but the sale of any real estate. And for ULA, it's in the city of Los Angeles that's in excess of 5 million.
And so there's a couple different tax rates we can talk about. But this includes residences, but it also includes commercial properties and any other property that's sold.
Yeah, and that's the interesting part. So you've got industrial, you've got retail, multifamily, commercial and you've got homes and there are definitely pockets and large portions of L.A. where they're homes that are worth north of $5 million.
Sure. And I would. But before we go into what would probably be a bunch of potential negatives, obviously the intent here is positive, right? The goal of this additional tax is to raise money for housing support. Right. For people who have low income or other issues. So it goes into a fund that helps support the development of affordable housing, you know, rent assistance, things like that.
So, you know, I don’t want to say that this is all bad. Obviously, there are always maybe unintended consequences when you do things like this. Yeah, but that was the purpose behind this, Right. Take, you know, the top percentage of sale transfers on real estate to help kind of the lower end to get everyone hopefully, you know, living somewhere.
So then thank you for kind of headlining that because there is a reason for it. It's not just a tax that somebody woke up and we do have housing supply shortages and you know the cost of living in cities and states like cities like L.A. and states like California is high. So there's a reason behind it.
Tell us a little bit about how this tax works. So it's for properties starting at $5 million, right?
Yes. So and that is the gross sales price. So we're not talking about net profit. So typically, taxes, various kinds are applied to the net profit, the money that you make. Yeah, this is a gross tax. So in other words, the moment your real estate sale goes, over 5 million or 10 million is the next level. It's just a little bit added tax.
The entire sales price is taxed at what would be now closer to 5% or 6% rather than closer to 1%, which is what it used to be.
Got it. So, you know, just round numbers, a $5 million property, a tax of 5% is $250,000. Right. And $10 million property tax of 5% is $500,000. Right. That can definitely affect a person's interest in buying in terms of what that cost would be. They might know that eventually they're going to have to sell this property so they might offer a lower price or the seller might know that they have to pay this tax they might want to list it at a higher price.
Yeah, I mean, it's sort of yet to be seen. The law went into effect just a few days ago and so it's sort of yet to be seen how this impacts the market. I know a lot of people are trying to get sales in, but there's some weird results on this because it wouldn't make sense. For example, to sell something for 5.2 million.
You actually net less than if you were to sell it for 4.99. Similarly at 10 million, right up to 10.5 wouldn't make sense. So there's going to be a weird pricing now that goes on with these properties to take into account. This tax that sort of comes off the top. And then, of course, the deterrent effect, which you might mention as far as people coming in and wanting to develop properties.
Yeah, you know, that whole value add real estate where, you know, somebody comes and they buy a piece of property, they add value to it, which is a very attractive way to invest in real estate. It could detract some of this. So is this just in Los Angeles or is it other parts?
So there are other places in California that have had similar rules or have enacted similar rules sort of concurrently. So if someone were to look at this and say, okay, it's City of L.A., so why don't I just go to Santa Monica? Well, Santa Monica has its own rules. Similarly, Culver City has its own rules. And then if you look up in Northern California, there's places like Palo Alto, San Francisco, that have a transfer tax that has been already in excess of what we do here. So I think people will be sort of shopping around. This is a new consideration when you're looking to develop something or buy something. Do I want to be under these city of L.A. rules? Culver City and Santa Monica, or do I want to be in Beverly Hills or Newport Beach where they don't have things like this?
So it'll be interesting.
Yeah. Thank you for bringing that up. And are there any other than maybe selling it at a slightly discounted price? Right. You've got a property that you think is worth 5.2 million and you just say, you know what, I'm going to list it for 4.99 to avoid the tax. Are there any other strategies people can consider to help minimize the tax?
Yeah. So I mean, none that I would feel comfortable today saying, like I've got the strategy for you. Yeah, a lot of people have had ideas. And so some of those ideas because we get these questions from our clients all the time.
Should I open up an LLC or some other type of structure?
Yeah, what if I split the parcels and I sell each one instead of 8 million sale, I sell two $4 million parcels? Well, the spirit of the law is that they want to tax real estate over a certain value. I think the likelihood that you could just split into two parcels and then turn around and sell it right away, maybe there's a strategy there.
We don't know what it is yet. What about breaking into multiple stages? I'll sell you half the property this year and then half next year. Well, typically with rules like this, if the contemplation is an overall sale over any time frame, Right. You look at this as one transaction and I would imagine the city is going to look at it the same way, which is you're just taking these steps, but really you want to sell the whole property and avoid the tax.
So that's likely not to work. Of course, this is new and we'll see. And then, of course, you mentioned business entities. First thing people say is, well, what if we just put it in an LLC, right? So our properties in an LLC, we sell the LLC interest. The title doesn't change, right? The cities none the wiser. It doesn't work that way.
Right. Even now, the old smaller tax, you know, the one and a quarter percent. Right. We still had to apply. It is actually a duty to report that you've sold the property. There's a certain amount of money that's been exchanged and you pay the city tax. So that doesn't work either. So not to be all bad news here, but I would say we need to kind of feel this out and see if there's any strategies before you really try to avoid this tax.
Yeah, And look, there's sometimes strategy that comes out about it, unintended consequences. And right now we're talking just on sales. So the sale of a property, if it's over five or $10 million, there's this extra tax. Oftentimes our clients like what's happened with us recently is how does this affect them with regards to inheritance or gifting?
Tell us a little bit about that.
Yeah. So the key to this law has to do with what's called consideration, which is obviously the transfer of some value for some other value. So it actually is a sale, a deal of some kind. So that would necessarily exclude anything like a gift which has no consideration. Right. This is someone that's just giving you something that doesn't mean you can on the side sneak, you know, some money or something.
That's a sale. It's just, you know, against the law to do it that way. So gifts are fine during life. Inheritance, right? That's not a transfer for value, right? We're not buying from our parents’ estate, for example. We're just inheriting something. So we should be okay there. Similarly, things like spousal transfers, transfers into business entities. So I own a building.
I want some asset protection. I want to put it in LLC just because I'm changing title, that's not a sale. So all of those rules that used to apply to the standard documentary transfer tax still apply because this is just an increase on that tax.
Yeah, no, thank you for sharing that. It's the rules kind of we get emotional about, you know, real estate or assets and inheritance and taxes and all this stuff. And so it's just important to make sure that we are bifurcating the difference between something like a transfer or a gift versus an actual sale. What are your thoughts? I've got some thoughts about the potential impact on the real estate market.
Do you have any thoughts on how that would work because we even talked about one of them, how these costs could potentially get passed on to the seller or the future buyer? Right. Yeah. Somebody sitting there saying, hey, I know that if I'm going to sell this property, I'm going to have to pay a larger tax. So I'm just going to sell it for more money than I would.
Right. The concern among some of my clients and obviously I'll defer to you on the financial picture, would be that in order to make this make sense, develop a property, rent it for some amount of time, sell it, the rents will have to be higher. And so the exact opposite of the purpose of this, you know, measure was to sort of help with, you know, people getting into housing, right.
Make it more affordable, but the money has to go somewhere. Right. If you're going to charge more money but you want your profits stay the same on the business side, it's possible, who knows, that it ends up in the rental. And so we're going to have those rents going up, which causes other rents to go up. And so we kind of have this game where you pull one lever and then another thing moves and it's hard to know. But I do have clients who will say, you know, the numbers have changed on this right? If my profit margin is 30% right now, it's you know, I'm making 20%. That doesn't make sense anymore unless I charge a little more rent or something like that. Right. Or I just go somewhere else.
And I think that that's the hardest part that I have with this is the unintended consequences of some of these things that get put into play that are meant to help the problem and then it ends up hurting it, Right? So the purpose of this is to raise tax dollars to be able to provide more affordable housing.
But what the end consequence or result could potentially be is that because of this tax rents need to actually go up. So housing affordability becomes less expensive in order to to account for this. Sure.
And the cities that need the housing the most don't have the same amount of development now. Right. And so that would also exacerbate the problem. Right. We don't want to encourage people not to...
Because there are people that might not want to go to L.A. and build because there's this extra tax. They might, like you said, go to Newport Beach or Beverly Hills.
Sure, because they're looking not only at the, you know, at the cost, but also just the attractiveness of the investment. Over time, many of our clients end up exchanging property out of California. Maybe they're retiring somewhere and they're looking at that, saying like, I know this is going to be temporary property for me. I'm going to sell it, you know, and you know, someone's going to have different properties to choose from.
Mine has this extra 5% tax tacked on, you know, and I just I don't want to eat that. So I'm going to have some, the buyer maybe there's a new thing where the buyer pays some, the seller pays some. It just makes it less attractive, you know? And so if you're envisioning a sale in the future for your planning or whatever your life is working out, to be, it just might not make sense.
Yeah. Brian, thank you so much for coming and talking about Measure ULA, the measure that's called the mansion tax here for L.A., where it institutes an extra tax on sales of real estate above $5 or $10 million in the city. In the city of L.A., again, it's called the mansion tax. Sometimes we think of homes.
But I think the largest area of the real estate market that it affects here in the city of L.A. is multifamily properties, commercial, retail or even potentially industrial. And it could have the adverse impact of higher rents.
Potentially, I mean, we'll see what happens, but I think that's a pretty good summary.
Yeah. Thanks so much.
You're welcome.
Disclosures:
Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and do not represent the views and opinions held by Morton Wealth. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your attorney, finance professional or accountant before implementing any transactions and/or strategies concerning your finances.
