Last month Los Angeles voters approved Measure ULA, imposing a new tax on all real property sales or transfers over $5 million. This will affect all parties involved in a real property transaction, and it is important to understand the implications of the measure before negotiating on a new project. My colleague David Tabibian, partner in JMBM’s Real Estate Department and Global Hospitality Group®, explains the initiative and its potential impact below.

In an effort to combat the homelessness crisis, Measure ULA (aka the “Homelessness and Housing Solutions Tax”) was recently approved by voters in the City of Los Angeles on November 8, 2022. The measure imposes a very significant increase in transfer taxes on certain real property sales within the City of Los Angeles, which will have far-reaching impacts throughout the real estate market. It is anticipated that the new tax will generate approximately $600 million to $1.1 billion annually in order to fund affordable housing and tenant assistance programs administered by the Los Angeles Housing Department. Given the high cost of this new tax, it is important that buyers, sellers and developers fully understand its implications.

What Does Measure ULA Do?

Although commonly referred to as the “mansion tax,” it is actually much broader in scope since it applies to all real property asset classes, including residential and commercial properties as well as vacant land. In fact, many industry experts anticipate much of the revenue generated from Measure ULA will instead come from sales of apartment buildings and commercial properties as opposed to sales of mansions.

Currently, unless a specific tax exemption applies, all transfers of real property, regardless of value, are subject to a documentary transfer tax from both the City of Los Angeles and the County of Los Angeles at a combined rate of $5.60 per $1,000 of consideration. Simply put, it is a 0.56% tax on the consideration received and is collected at the time of closing.

Under the new measure, however, sales of residential and commercial real property valued at over $5 million but less than $10 million would be subject to an additional transfer tax at the rate of 4%, and sales of real property valued at $10 million or more would instead be subject to an additional tax at the rate of 5.5%. In contrast to the existing documentary transfer tax, the value of the property for purposes of the measure will include the value of any lien or encumbrance remaining on the property when it is sold so that the tax is on the gross value, not just the consideration received. Moreover, the tax would be due regardless of whether it is being sold at a gain or a loss. The thresholds under the measure will be adjusted each year for inflation. Although Measure ULA will become law on January 1, 2023, it applies to property sales occurring on or after April 1, 2023.

Any transfers valued at $5 million or under are not subject to the new tax. Also, property transfers with “qualified affordable housing organization” transferees, certain non-profit transferees and governmental transferees will be exempt from this tax. It does appear that the same general exemptions currently applicable to the existing documentary transfer taxes would also apply to the new tax, but it is still unclear what, if any, other exemptions may apply and how they might be interpreted and enforced.

As an example, a property sale valued at $50 million would currently be subject to a $280,000 documentary transfer tax under the existing rules, but will now be subject to an additional transfer tax of $2,750,000 under the new measure, totaling over $3 million due at closing just in transfer taxes alone.

What Are The Potential Impacts?

Measure ULA is expected to cause a ripple effect throughout the Los Angeles real estate market. It could end up causing rents to go up by raising development costs, which would be directly counter to the measure’s principal objective. Market-rate construction is necessary both to alleviate the pressure on the housing market and to furnish the sales that generate the revenue for these subsidies. It can further disincentivize both developers from building new construction and buyers from investing in the City of Los Angeles, and instead drive them to do transactions outside of city limits where this tax won’t apply.

Additionally, critics have argued that this new measure may have little impact on the homelessness crisis, similar to Measure HHH, the ten-year $1.2 billion bond measure that was passed by Los Angeles voters in 2016 to address homelessness by building 10,000 new affordable and permanent supportive housing units. In the six years since Measure HHH was passed, homelessness in Los Angeles has dramatically increased.

How To Deal With The New Tax?

Only time will tell how this new tax will change the way real property transactions are customarily negotiated between parties. Sellers may use this opportunity to get buyers to split the new transfer tax equally between them (currently, the custom in California is that sellers typically pay all documentary transfer taxes). Broker commissions may also get squeezed, especially when you factor that closing costs (e.g., transfer taxes, brokers’ commissions, escrow and title fees, and other transaction costs) on high-value real property transactions can now eat up over 10% of the property’s sales price.

On multi-parcel properties, sellers may attempt to split them into separate sale transactions to try and fall under the thresholds and avoid the new tax, but it is too early to tell if this will be permitted by the taxing authority. However, acquiring the legal entity that owns the property on title is unlikely to avoid the tax since a change in ownership of an entity that owns real property is currently viewed as a taxable event.

Regardless of the deal structure, clients are recommended to incorporate this new transfer tax into underwriting of existing and future projects.

Please contact us if you have any questions on Measure ULA and how it might impact your next real estate transaction.

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Jim Butler
+1 310 201 3526
JMBM

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