What is the mansion tax and how does it affect NNN lease buyers?

Sep 15, 2023

What is the mansion tax?

A ‘mansion tax’ is a real estate transfer tax that applies to properties that sell over a certain amount, though the exact amount varies by state and even city. The homebuyer typically pays the mansion tax as a percentage of the home’s sale price. In New York City, for example, the mansion tax applies to any residential property that sells above $1 million — even if it’s a studio apartment, including co-ops and condos.

What states have a mansion tax?

As of July 2023, only 7 states have a mansion tax. They either levy a surcharge on the highest-value homes or have a progressive bracket structure through their real estate transfer tax system.

  • Connecticut: 2.25% on properties exceeding $2.5 million
  • District of Columbia: 1.45% on properties sold for $400,000 or more
  • Hawaii: Marginal rates between 10% and 20% for estates valued at over $5.49 million
  • New Jersey: 1% on real estate purchases over $1 million
  • New York: 1% to 3.9% on residential purchases of $1 million or more
  • Vermont: 16% on properties valued over $5 million
  • Washington: Graduated rates at 1.28% for properties sold at a minimum of $500,000

There’s plenty of precedent for transfer taxes, which have been used for years to generate funds in major cities. While usually enacted at the state level, mansion taxes can also be levied in specific cities (as with New York).

  • In 2018, Oakland, California, passed a measure increasing real estate transfer taxes in a series of increasing price brackets, while reducing rates for first-time buyers below a certain income threshold.
  • San Francisco has a six-tier system that starts at 0.5% for sales above $100 and maxes out at 6% for sales above $25 million.
  • New York City charges a 2.075% tax paid by the seller for property sales that exceed $3 million as well as a mansion tax paid by the buyer that ranges from 1% to 3.9% depending on purchase price.In 2020, Culver City approved a marginal four-tier transfer tax, starting at 0.45% for sales below $1.5 million and maxing out at 4% for sales above $10 million.

While the state of California doesn’t currently impose a mansion tax, Los Angeles County does. Los Angeles County’s mansion tax went into effect in April 2023 and levies a 4% tax on all Los Angeles properties sold or transferred above $5 million or more, and 5.5% for properties sold or transferred for above $10 million. Known as Measure ULA — for United to House LA — Los Angeles’ mansion tax would include a $200,000 tax on a $5-million residential real estate sale, and a $550,000 tax on a $10-million sale, which is typically paid by the seller.

An analysis published by UCLA’s Lewis Center for Regional Policy Studies found the tax will affect only about 4% of overall real estate transactions in a given year, including commercial, and less than 3% of single-family home and condo sales. It’s a small percentage with a big effect: If the tax had been in place on sales in the city from June 2021 to June 2022, it would have raised more than $900 million, which would be earmarked to fund affordable housing — a massive increase from the $207 million that existing transfer taxes currently raise annually at the rate of 0.45%.

Real estate interests are now fighting the new law in court, arguing that it violates California’s constitution.

Why does the mansion tax matter?

Mansion taxes are designed to decrease the tax burden on an area’s lower-income residents by taxing wealthier home buyers, with proceeds funding public services such as transportation, housing, and education. For buyers of high-cost properties, a mansion tax can add significantly to the upfront costs of buying a home. Since LA established their mansion tax in spring 2023, real estate pricing strategy has shifted, as some price just under mansion tax thresholds to make properties more enticing to buyers. Buyers need to factor this transfer tax into their overall budget when purchasing a property.

Impact of the mansion tax on NNN lease buyers

1031 exchanges apply to real estate that has been held for productive use in a trade or business or for investment and therefore do not apply to a taxpayer’s primary residence, second home, or vacation home. They allow the buyer to defer capital gain and depreciation recapture taxes.

In some cases, a 1031 exchange can apply to a primary residence. Section 121 of the IRC states that a personal residence can be exempt from capital gains tax through a 1031 exchange if an investor has owned the property for at least five years and lived in it for two out of those five years. To be eligible for the exchange, you must be able to show the IRS that you rented out the property at market rate and actively prove that you lived elsewhere while using the property for business purposes.

Section 1031 exchanges do not defer or abate transfer taxes, mansion taxes, and similar taxes imposed at the sale or transfer of property. However, mansion taxes are accounted for in the real estate transaction, and do reduce the amount you, the taxpayer, must replace.

You can read our full guide to completing a 1031 exchange here.

1031 exchange timeline graphic

Long-term ROI of NNN lease properties exceeds the short-term cost to purchase.

NNN lease purchases are long-term investments. Buyers most affected by the mansion tax will be the people who want to build property and flip it immediately, as the one-time mansion tax is a small percentage of average property appreciation year-over-year.

In standard commercial lease agreements, some or all of the costs to operate a property would be your responsibility. While there are up front costs to purchasing a NNN lease property, after the purchase is complete, your tenant will pay all property expenses, including real estate taxes, building insurance, and maintenance in addition to the cost of rent and utilities.

NNN investments mimic fixed-income investments by providing asset and income growth, strong current yields, long-term predictability, and steady cash flow for up to 20 years or more. If you already own residential rentals, multi-tenant properties, or apartment buildings, it may be time to let go of the headache of high-maintenance investments and earn a comparable ROI and a stable monthly income without the hassle.

Before you make an offer on a NNN property, you’ll want to make sure that you’re aware of any higher-than-average transfer taxes. Let Westwood become your trusted team of advisors to guide you through the complex process of purchasing your NNN lease property.

To learn more – our no-obligation consultations are free – contact our advisors today. 314-997-5227

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