How Does LA’s New “Mansion Tax” Affect the Sale of Foreclosed Properties?

Property owners in Los Angeles are facing challenges on more than one front. The foreclosure rate rose in Q4 2022 while the FED has continued with the rate hikes it started last year. At the same time, LA office leasing activity is declining as tech companies flounder and other industries struggle to bring workers back to the office. Unfortunately, LA’s new “Mansion Tax”, which went into effect on April 1, 2023, is one more bit of bad news. It affects not only residential and commercial property owners but also financial institutions that need to sell foreclosed properties.  

How Does the “Mansion Tax” Affect Property Owners?

Los Angeles’ “Mansion Tax”, designed to help the city raise funds for affordable housing. It imposes a 4% tax on all property sales worth between $5 million and $10 million. The tax rate rises to 5.5% on sales worth more than $10 million. Any property owner who sells property in this price range will need to pay the tax bill outlined in the new law. This includes not only owners of residential and commercial properties but also developers, property flippers and real estate foreclosure sellers. 

The law does not provide any sort of relief for financial institutions that offer mortgage loans for residential or commercial properties. This is true even if they are selling the property at a loss. A lender who has loaned a borrower $20 million for a residential or commercial real estate purchase, for instance, but is then forced to foreclose after a year or so may not only have to sell the property for less than the initial loan amount but also pay a hefty tax on the sale. If the lender sells the property for $15 million, for example, the lender will need to pay an $825,000 tax bill on the sale.  

What are an Investor’s Options?

Investors in this situation have a few options. They can hold on to the property in question in the hope that the city will eventually overturn the new law. However, high property tax rates and maintenance costs can make this option prohibitively expensive. They can raise the asking price to pass on some or all the added expense to the buyer. This can be an option if there is high demand but may not work well in instances where demand is low and/or the inventor needs to sell right away. Another option is to split the property into two or more parts owned by different entities and then sell each part at $4.999 million or $9.999 million to minimize tax expenses. Consulting a real estate lawyer may be wise if one decides to go this route to ensure no mistakes are made in the selling process.  

Experts predict that the new tax, which can equate up to 30% of developer profits, will lower investment in LA’s real estate market. Developers and investors alike will likely look for more profitable real estate markets. Buyers will reconsider investing in a market in which a sale could come with a six or even seven-figure tax bill. Lenders holding foreclosed real estate will want to carefully assess their options to determine the best way to hold or sell repossessed properties in order to maximize potential profits while keeping expenses as low as possible. 

If you or someone you know has questions about the current foreclosure climate, our experts at Peak Foreclosure are here to help.

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