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The “Mansion Tax” and Its Effect on the Future of Real Estate Transactions in Los Angeles

The United to House LA measure (Measure ULA), approved by Los Angeles voters in November 2022, established a new Homelessness and Housing Solutions Tax, often referred to as the "Mansion Tax."  The Measure imposes additional taxes on high-value property transactions to fund projects and programs to address homelessness in the City of Los Angeles.  The breadth and various nuances of Measure ULA, which came into effect on April 1, 2023, are important to understand when considering a real estate transaction in the City of Los Angeles.

For starters, the tax goes beyond traditional concepts of a "mansion tax," as it applies to all types of real estate in the City of Los Angeles, not just residential properties or “mansions.” Any form of property - from commercial buildings to multi-family units, condos, and undeveloped land - falls within its purview if the sale price exceeds $5 million.

Property owners in the City of Los Angeles and investors of all types should be familiar with the following basics:

Tax Threshold and Rates: The tax is set at a graduated rate of 4% for properties valued between $5 million and $10 million, and 5.5% for properties valued at or over $10 million.  Important to note is that these values are gross values, including liens and encumbrances, unlike existing documentary taxes discussed below.  It is also critical to understand that these thresholds are applied to the totality of the sale value, not just the amount that exceeds the thresholds.

Effect on Existing Taxes: The tax introduced by Measure ULA is in addition to the existing documentary transfer taxes (City transfer tax of 0.45% and County transfer tax of 0.11%).  This means that for high-value property transactions, sellers are required to pay both sets of taxes, compounding the total tax burden.

Annual Adjustments for Inflation:  Thresholds are to be adjusted for inflation each year; the tax is thus intended to keep pace with rising property values and general economic conditions over time. 

Payment of ULA Taxes:  ULA Taxes are payable in full at the time of the real property transaction.  Payors may file a claim for a refund of the tax within one year of payment.  Such a claim would require the payor to indicate the grounds for the claim, notify the City of the claim, and potentially follow up with a lawsuit if the claim is initially denied. 

The impact of Measure ULA on the Los Angeles real estate market will likely unfold over a long period and may be influenced by a variety of other market and economic factors.  The following are a few of the potential outcomes based on current analysis and predictions:

Decline in Property Sales: The tax has reportedly contributed to a decline in property sales across various sectors, due to the added cost burden imposed by the tax, which may be dissuading potential buyers, especially at the higher end of the market.  The potential for slowed market activity due to the tax could also affect broader economic activity, given the substantial role that the real estate sector plays in the overall Los Angeles economy.

Effect on High-Value Transactions: The tax specifically targets high-value transactions with its $5 million threshold.  This has particular implications for the luxury real estate market and commercial properties, traditionally sectors with transactions over this threshold.  Since the passage of Measure ULA, these sectors have reported measurable declines, reflecting concerns about increased costs leading to slimmer profit margins.

Impact on Future Developments: Measure ULA could potentially affect future real estate developments within the city limits of Los Angeles.  Developers may be hesitant to undertake high-value projects if they anticipate difficulties selling the properties due to the added tax burden.  Alternatively, developers might pass on the increased cost to buyers, which could impact the property's marketability.

Effects on Rent Prices: There is speculation that Measure ULA may indirectly lead to increases in rental rates.  If property developers and owners face higher costs due to the tax, they may attempt to shift these costs by increasing rents, impacting both commercial and residential tenants.

In the face of the considerable financial burden imposed by Measure ULA, several mitigation strategies have been developed with a goal of minimizing the Measure’s impact:

1. Tenancy in Common Structure: One prominent strategy is using a Tenancy in Common (TIC) structure for property ownership.  In this arrangement, a property is divided into individual interests, each held by a separate party in a TIC ownership structure.  From a taxation perspective, each owner's interest could potentially be considered separate for the purpose of the ”mansion tax” calculation.  For instance, if a $6 million property is owned by four parties under a TIC ownership structure, each party might be considered to own, and potentially to sell, a $1.5 million interest, thereby avoiding the $5 million threshold for the mansion tax altogether.  Implementing such a structure could, however, be complex, requiring careful legal planning and agreement among the owners.

2. Seller Carry-backs:  A "seller carry-back" strategy might also prove effective in deferring the impact of Measure ULA.  In this situation, part of the property purchase price is financed by the seller.  This essentially becomes a loan from the seller to the buyer, with the property serving as collateral.  The carry-back mortgage reduces the buyer's upfront payment, thus potentially reducing the amount subjected to the mansion tax at the point of sale.  Over time, when the buyer pays back the loan through installments, these payments might avoid being subject to the tax, as they could be considered as occurring after the transfer of ownership rather than as a part of it.  It is important to note, though, that such an arrangement would require a willing buyer and seller, and may also carry risks and complexities not found in a straight sale.

These potential strategies carry varying degrees of legal, financial, and logistical implications.  Property owners are advised to seek professional legal and financial advice before pursuing these or any other tax mitigation strategies.

Lawsuits challenging the validity of the ULA tax have so far been unsuccessful.  A citizen initiative called the “Taxpayer Protection and Government Accountability Act” has qualified for the November 2024 ballot.  While not directly repealing Measure ULA, the initiative, if passed, would have the effect of invalidating it.  Until then, Measure ULA  is the law of the land.

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