California continues to be a leader in demonstrating that American states and cities can serve as “laboratories of democracy.” The latest experiment, in Los Angeles, targets high-value homes and other multi-million dollar properties, and has already had a significant impact on the real estate market.
Last November, Los Angeles voters approved an initiative that imposes additional taxes on the sale of expensive real estate. Although described by some as a “mansion tax,” the tax applies to more than just single-family properties and includes apartment complexes, retail and industrial buildings, and other structures. An additional 4 percent sales tax will be imposed on homes that are sold for more than $5 million, and for sales above $10 million, the tax goes up to 5.5 percent. That’s a hefty additional $550,000 payment that must be forked over at closing of the sale of a $10 million property. The proceeds of the tax are supposed to be earmarked for subsidized housing, housing acquisition and rehabilitation, rent assistance and homelessness-related programs.
A $5 million or a $10 million property seems like a lot of money–but not when you are talking about a market like Los Angeles, where the real estate prices are out of whack with those in the Midwest and other, non-coastal areas of the country. It’s hard to imagine that any multi-unit apartment building or industrial building in Los Angeles, for example, wouldn’t carry at least a $5 million price tag and be subject to the tax.
In any case, the tax, which became effective on April 1, has already had a significant impact on the Los Angeles market. In the days leading up to the tax, desperate would-be sellers, who would be responsible for paying the tax, tried to unload their properties before the effective date. Real estate brokers offered unusual, “only-in-California”-type deals as an incentive to close before the deadline, like offering $1 million bonuses to brokers who could bring in a buyer for a particular property or offering luxury cars as throw-ins on particular sales. From the sounds of it, things got pretty frenzied as April 1 approached.
The bigger question, though, is what the tax will mean for the L.A. real estate market going forward. The impact will be felt not only by people who previously bought properties for prices above the $5 million and $10 million cut-off points, and now must swallow a large tax hit when they reach the point of selling, but also potentially by residents of existing multi-unit structures whose owners also know that an impending tax bill lies ahead in the event of a sale. How many commercial property owners will scrimp on maintenance and upkeep to account for the tax? And, more broadly, how many developers who might otherwise have built desperately needed new housing in Los Angeles now will choose to build instead outside of the city limits, where the tax won’t have an impact on the value of their property?
There’s a vigorous debate about whether the tax will have a significant impact, or simply be absorbed into the pricing calculation in one of the most high-priced real estate markets in the country. It will be interesting to keep an eye on Los Angeles and its laboratory of democracy experiment that will test the impact of a tax.