ULA Law Confuses Investors, Threatens Dealmaking
The Fashion Institute of Design & Merchandising paid a nearly $900,000 ULA tax in what it says is an error after selling its 919 S. Grand Ave. building to Arizona State University in July 2023. (CoStar)
By Jack Witthaus
CoStar News
January 28, 2024 | 2:58 P.M.
Earlier this month, the University of California bought a former Los Angeles mall for $700 million with plans to create a world class research lab. The deal also created something for the sellers: a major tax benefit.
The owners were exempted from paying a new city transfer tax, nicknamed the "mansion tax," because the buyer was a public institution.
Those same rules weren't applied when the governing body of another public university system, the Arizona Board of Regents, bought a downtown property last year in a deal that forced the seller, the Fashion Institute of Design & Merchandising, to pay $892,500 in transfer taxes.
CoStar News reviewed dozens of deeds collected by CoStar for commercial property sales priced above $5 million since April 1, 2023, when the transfer tax took effect, and discovered a wide variance in how the levy has been applied. The differences have spawned confusion among property investors at a time when voters are preparing to reconsider whether to continue to tax.
The status of the buyer determines whether the transaction is exempt from the new tax. Deals involving certain nonprofits, government or public entities and housing cooperatives are exempt, for instance. The law makes sellers largely responsible for paying the tax.
CoStar News, however, found the tax was paid on some deals that involved nonprofit or government buyers. In other cases, the review showed the tax was not paid on deals involving similar entities.
Confusion over who pays the transfer tax — officially called ULA, or United to House LA, after the referendum that created it — comes amid mounting tension between supporters and critics of the law, with other cities watching from the sidelines as they consider enacting similar taxes to address housing challenges.
The new tax "is definitely not black and white," according to Michael Wiener, a Los Angeles real estate attorney and partner of Greenberg Glusker. "There's a lack of guidance. It's challenging to give your clients the best advice."
Supporters of the tax note the funds it raised are already being put to use to address affordable housing challenges in Los Angeles, while critics are looking to an upcoming state ballot measure that could repeal the mansion tax altogether.
Auditing Process
The sellers involved in the University of California deal — Hudson Pacific Properties and Macerich — were exempt from paying more than $40 million in taxes because the buyer was a public university.
Meanwhile, the Fashion Institute of Design & Merchandising is appealing the transfer tax it paid when it sold its building at 919 S. Grand Ave. to the Arizona Board of Regents. The school applied for a refund on Aug. 28 from the city of Los Angeles Office of Finance, which handles transfer tax refunds, said Angela Hawekotte, the institute's vice president and treasurer.
A city spokesperson told CoStar News the institute's claim is under review.
"We have not been given any indication of when the funds will be returned," Hawekotte said.
The city is developing an auditing process for transactions that involve the new tax to mitigate confusion, a spokesperson told CoStar News.
As of November, the city collected $142.7 million from the transfer tax, well short of the $1 billion the levy had originally been projected to generate. That figure may change after the city audits its own records and determines whether payments, or nonpayments, were appropriate.
Exemptions
The tax, approved by Los Angeles voters in November 2022, is being used to fund initiatives to protect renters and combat homelessness in Los Angeles, a city struggling with one of the largest such populations in the nation. The Los Angeles City Council has approved initial new transfer tax funds to develop affordable housing, assist tenants through eviction defense and even help struggling landlords of affordable properties.
Since April, this 4% tax has been levied on nearly all commercial and residential property sales or ownership transfers above $5 million in Los Angeles, while a 5.5% levy is charged on properties selling or transferring above $10 million. Before April, each of those taxes was 0.45%.
Exempt groups can include affordable housing organizations, nonprofits and government agencies. However, real estate professionals say not all the tax's rules have been ironed out yet, and there's still fuzziness around who may qualify for an exemption.
These gray areas exist despite the tax being in effect for more than eight months, during which Los Angeles — the nation's second biggest city and among the nation's most active commercial real estate markets by sales volume — saw billions of dollars in sales or transfers for all commercial property types, according to CoStar data.
Michael Wiener of Greenberg Glusker said he's seen the tax inconsistently applied in deals he's worked on with clients, adding the city of Los Angeles hasn't created more regulations around the tax that would help clarify some of its ambiguities.
"You have things going every which way," Wiener said.
Sharon Sandow, public information officer for the Los Angeles Housing Department, said the city's Office of Finance has received 14 refund claims of which three are seeking exemptions from the tax and 11 are challenging the tax's legality, Sandow said.
The city has not yet pursued anyone for unpaid transfer taxes, Sandow said, but it's likely to start reviewing records going back to April 2023 to pursue collections wherever it seems appropriate. The city's finance office is creating an auditing process to help it do so.
"When the audit firm is in place it will be looking at transactions that occurred that should have sought exemptions or paid taxes," Sandow said.
Challenged Dealmaking
Sean Burton, CEO of Los Angeles-based apartment owner and developer Cityview, said any confusion around the new transfer tax makes a bad situation worse for property investors and developers.
"It erodes confidence," Burton said. "It makes it more difficult to get the predictability you need to make the investments to address our housing crisis."
Burton notes the new transfer tax, combined with rising interest rates and economic uncertainty, chilled the greater Los Angeles real estate market last year. Roughly $21.5 billion in commercial property sold in Los Angeles County in 2023, down from $41.2 billion in 2022, according to CoStar data.
"There continues to be massive concern about the impact," Burton said.
Joe Donlin — who helped craft the language around the new transfer tax and who is the director of United to House LA, which advocates for the tax — said the levy needs to be applied properly and attention needs to be paid to those trying to evade the tax.
Despite the confusion created by the law, Donlin notes there has been enough tax money collected to fund more than 700 affordable homes in Los Angeles and tens of millions of dollars toward rental assistance.
"While there may be some hiccups, the dollars are being collected and being put to use as intended," Donlin said.
The tax has been watched nationally by other cities attempting to address similar affordable housing and homelessness problems. Chicago voters are preparing to decide on a tax this year that's similar to L.A.'s tax in that it would go toward addressing homelessness issues; Seattle voters recently OK'd a property tax aimed at helping low-income renters; and voters in Santa Fe, New Mexico approved taxes on residential sales exceeding $1 million to build more affordable housing.
Higher transfer taxes on pricey property sales have been employed in various United States cities. In New York, for example, a roughly 2.6% transfer tax is charged on some commercial transactions above $500,000 in addition to a state tax on certain transactions above $2 million. In San Francisco, a transfer tax of 2.25% is charged on some properties selling above $5 million with larger taxes enacted on applicable properties selling above $10 million and $25 million.
Potential Cancellation
The confusion and concern around Los Angeles' new transfer tax may result in the measure's cancellation, critics say.
In November, California residents are set to vote on a state ballot initiative aimed at dismantling special tax increases like L.A.'s mansion tax, called The Taxpayer Protection and Government Accountability Act.
If passed, the law would require two-thirds voter approval for all new local special tax increases, upending special tax increases like L.A.'s mansion tax that didn't reach that voter threshold when it passed. Los Angeles' new transfer tax would not be grandfathered in if the act passes, and any transfer tax money already paid to the city would not be returned to taxpayers.
A lawsuit challenging the tax's legality aims to return money back to ULA taxpayers. The lawsuit, filed by the Apartment Association of Greater Los Angeles, lost an initial court ruling and its plaintiffs are appealing that decision.
"We're still certain we're going to crush the city on this," said Dan Yukelson, executive director of the association. The Los Angeles City Attorney’s Office didn't respond to an emailed request to comment.
Wiener expects the state ballot initiative to pass and to repeal the new levy.
"Hopefully come this time next year we're done discussing these ambiguities," Wiener said.