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INSIGHT: The Pied-A-Terre Tax and Its Detrimental Impact on the NYC Real Estate Market

March 29, 2019, 1:41 PM

As part of Governor Andrew Cuomo’s (D) effort to raise funds for the New York City subway system, he is proposing a “pied-a-terre” tax on all properties that are purchased for $5 million and above that are not used as a primary residence.

This tax would be an annual tax based on the original purchase price of the property in addition to traditional property taxes and would start at 0.5 percent of the purchase price and could be as high as 4 percent per annum.

It is of no secret that the real estate boom in the New York City market since the great recession of 2008 has been driven by money from overseas and the super wealthy of the U.S. During this time, a negative stigma has been attached to the luxury real estate market by politicians and the media. Given the rising costs of land and construction, new development over the last decade has been largely tailored to the ultra-high-end market.

This is mainly due to the fact that the returns on investment only made sense to developers if they created a product tailored to this segment of the market. Regardless of your political views, the fact is the New York City local real estate market has become largely dependent on demand from overseas and the non-primary residence buyers.

The demand that these buyers bring to New York City market has certainly created a number of jobs in the city and also increased revenue to the state and city by hundreds of millions of dollars through transfer tax revenue, mansion tax revenue, and increasing the assessed valuation of properties throughout the city.

Given this sentiment, it is understandable to want to tax pied-a-terre owners and investors of properties in New York City when taking into consideration that they do not contribute to the local economy by paying city and state income and employment taxes (on local full-time employment) and do not substantially contribute to the city’s stores and restaurants, and thus, do not generate sales tax revenue or inject capital into local businesses. However, this position is not entirely accurate.

According to Jonathan Miller of Miller Samuel Inc., “the majority of new development units purchased as non-primary were rented out which is why the high-end rental market was crushed by all the new development condo sales by investors. Renters in these units do spend and help drive the local economy. Manhattan is about 75% rental by unit and New York City is about 2/3 rental by unit.” The notion that these buyers are absentee occupants of properties and international billionaires who own units that remain without the lights ever being turned on is false.

In 2013, the city began taking measures to cut tax breaks for non-primary resident owners. Property taxes on co-ops and condos have always been valued as rentals by state law, which had a 17.5 percent abatement until 2013. In 2013, the city began phasing out this abatement for owners of co-ops and condos who used them for investment purposes and pied-a-terres. This made perfect sense, as it was an actual property tax abatement that was taken away as opposed to an additional tax.

This change in law had zero impact on the New York City real estate market. Furthermore, it has been well documented by several major media outlets that developers were receiving tremendous property tax benefits through the 421-a and J-51 programs, which provided affluent purchasers of new development condos a break on property taxes north of 90 percent.

Mayor Bill de Blasio (D), in his affordable housing initiative, was successful in changing the property tax abatement program to only be available to developers who created in their projects an affordable housing component of 20 to 30 percent of all units (depending on zoning). Otherwise, their buildings would not be eligible for a tax abatement, which theoretically could impact the demand for condo purchasers. It is evident that the city has already begun increasing tax revenue through eliminating various property tax benefits for pied-a-terre and investment owners.

Adding an additional tax for buyers of units valued over $5 million is not as crazy as it sounds at face value. However, the manner in which this tax is created and implemented will be the determining factor on whether it is catastrophic for New York City real estate market. As it stands now, the tax as proposed would be crippling for the residential market.

First, the proposed manner in which the tax would be calculated is illogical. According to John Banks, President of the Real Estate Board of New York (REBNY), the proposal interferes with how property tax is calculated, because “it changes the way property is going to be taxed from an assessment base which is the current system to a sales base which is not part of the city’s property tax system.”

This raises the question if the implementation of such a formula would even be legal. Peter L. Faber, who is a partner at McDermott Will & Emery, even went so far as to say “..the problem comes when you start imposing a special tax on nonresidents. That is unconstitutional under the interstate commerce clause” This tax does not necessarily single out non-residents as it applies to non-primary residences regardless of their citizenship or residency status (meaning including New Yorkers).

Banks went on to comment on a potential additional closing cost being imposed for properties over $5 million (such as the “mansion tax”) by stating “most of them are a one-time transaction tax. So you know going into the purchase decision what your liability is going to be.” Something to this effect would have nowhere near the detrimental impact as a tax that could vary between 0.1 percent and 2.7 percent of your purchase price above $5 million per annum (depending on your actual purchase price—i.e. a property valued at $20 million would have to pay 1.1 percent or $220,000 annually for this tax).

The city should learn from the Amazon debacle, which resulted in over 25,000 potential jobs being lost and billions of dollars of future tax revenue being thrown out the window, in deciding how to implement a tax on the ultra-wealthy real estate investor in New York City.

If Amazon taught us anything, it is that New York cannot be arrogant enough to think that demand will not go elsewhere, if the other locale is more appealing and welcoming. Implementing this tax, if not done properly, will certainly result in the targeted demographic going to other more desirable markets which could lead to a collapse in our real estate market.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Pierre E. Debbas is a partner and founding member of Romer Debbas LLP. His practice focuses on the purchase and sale of commercial and residential real estate in New York City, commercial leasing, real estate related financing matters, representation of cooperative and condominium boards, foreign investors and small businesses.