Nine Ideas to Avoid the Effect of Measure ULA - The New Mansion Tax
The so-called “mansion tax” approved by Los Angeles voters in 2022 and effective April 1, 2023 (Measure ULA) is a misnomer. It establishes a new 4% documentary transfer tax on the sale of any real property priced or valued from $5 million up to $10 million and a 5.5% tax on real property sales priced or valued at $10 million or greater. This is in addition to the current base transfer tax. Measure ULA applies to more than just large homes. It applies to apartment buildings, raw land and commercial and industrial real estate. Anytime a sale price for real property exceeds $5 million in Los Angeles and the transfer document is recorded, this new tax for selling property kicks in at a rate of nearly eight times the current transfer tax.
Measure ULA matches and fits into the existing base transfer tax ordinance. The deficiencies in the wording of the ordinance may not have mattered too much when the transfer tax was solely .56%. They may matter more now. Below are strategies, some of which are untested, that could allow a creative real estate seller to minimize or negate the new and onerous Measure ULA additional transfer tax.
Measure ULA is poorly drafted. It provides: “there is hereby imposed a tax known as the ‘Homelessness and Housing Solutions Tax’ on each deed, instrument or writing by which any lands, tenements, or other realty sold within the City of Los Angeles shall be granted, assigned, transferred or otherwise conveyed to, or vested in, the purchaser or purchasers, or any other person or persons, by his or their direction, when the consideration or value of the interest or property conveyed (including the value of any lien or encumbrance remaining thereon at the time of sale) exceeds: (1) $5,000,000 but is less than $10,000,000, a tax at the rate of 4% of the consideration or value; or (2) $10,000,000 or greater, a tax at the rate of 5.5% of the consideration or value.” Based on a strict reading of the statute, there appear to be planning opportunities that may avoid, minimize or defer payment of the tax.
(1) Divided Interest. The mansion tax is a documentary transfer tax imposed on the sale of a single real property interest. Partnerships, corporations, or limited liability companies might avoid the new tax by selling interests in the entity which owns the asset rather than selling a fee the entire fee interest to one buyer. Let’s say I have a $10 million property held in an LLC. I can sell 50% of the interest in the LLC to one buyer and 50% to another distinct buyer with different ownership composition. No base transfer tax or additional mansion tax is chargeable as long no one acquires more than a 50% controlling interest.
(2) TIC: Two spouses (or business partners) take title to real property as tenants common (TIC). Now you have two separate tenants in common owning the property. When they are ready to sell the property, one spouse (or partner) can list their $5 million TIC interest for sale, and the other can list their TIC interest for $5 million.
(3) Ground Lease: A real property owner might enter into a 34 year ground lease for a set sum (as long as the lease is under 35 years there will be no change of ownership and transfer tax due), and then an option to purchase which is only exercisable after 10 years for an additional amount. This would accomplish deferring the tax as long as it were found to be a genuine option supported by adequate consideration and not a disguised purchase. One of the effects of the tax could be more ground lease sales or lease option contracts.
(4) Seller Carry-Back: This strategy could involve a seller carry-back at a very high interest rate. For example, a seller might reduce the property sales price from $6 million to $5 million with the buyer paying a much higher interest rate. The transfer tax is avoided yet the seller obtains the same total rate of return.
(5) Sale of Improvements. A seller might sell furnishings, personal property, and removable improvements for one price—say $1 million—and the land for $5 million. The question will then become what interests are real property interests sold versus other types of property for which Measure ULA does not apply.
(6) Separate Sales of Interests: Let’s say there is a segregable easement or other servitude or other non-fee interest connected with the property. Theoretically, one could sell each interest separately from the rest of the property in a different sale transaction or to a different party.
(7) Split Interests: In this scenario, a seller splits the property into parts owned by different legal persons or the same person. One could obtain a lot line adjustment or subdivide in advance of sale. An effect of Measure ULA will be to encourage subdivisions and lot line splits. Smart sellers will break sales into parts.
(8) Broker’s Fee: In this strategy, the buyer (and not the seller) contracts to pay the broker’s fee associated with the sale so that the broker’s fee does not come out of the purchase price. This might tend to reduce the Measure ULA tax payment due if by tens of thousands of dollars. The structure of listing contracts might change as a result of Measure ULA.
(9) Estate Planning: The property could be transferred tax free to multiple family members or trusts. The sub-trusts or the beneficiaries might then sell their own distinct interests at under the $5 million threshold and as part of a larger sale. Almost certainly, a good tax and estate planning lawyer will come up with ideas to effectuate this or a similar strategy.
Measure ULA is new, and planning to avoid or mitigate it is largely untested. These are ideas based on a strict reading of the statute, and any planning should involve your advisors. Absent creative lawyering, Measure ULA will likely hurt commercial investors more than homeowners. Most homes are sold for less than $5 million. This is why voters approved Measure ULA. Yet the vast majority of voters probably did not realize that when an apartment building is sold, land is developed or office buildings or industrial or retail real property are purchased, the law will likely hit the public hard. Application of Measure ULA may have the effect of spreading the tax to everyone by way of price increases for renters and consumers.