UPDATED April 3, 2022, 12:52 p.m.: The real estate industry in California is aghast at a state lawmaker’s proposed 25 percent capital gains tax on house flippers.
But the bill might be even harsher than they realize.
The profits from flipped houses are already taxed in California, which has the highest state income tax in the U.S. — as much as 12.3 percent. The proposed California Housing Speculation Act, AB 1771, would add the 25 percent tax to the existing capital gains levy on houses sold within three years.
The surcharge would be reduced by 5 percentage points annually in the fourth through seventh year of ownership, then disappear.
California taxes capital gains, such as from house flipping, at the same rate as ordinary income. For earners in the state’s top tax bracket, the new measure would nearly triple the tax on profits from homes sold within three years of purchase. An individual earning around $100,000 a year — who currently falls into the 8 percent bracket — would pay as much as four times more on flip profits.
The bill introduced last month by Assembly member Chris Ward, a San Diego Democrat, is intended to discourage house flippers, who buy and remodel houses for quick sales. The idea is to reduce competition for bidders who intend to live in the home being sold.
It was prompted by rising housing prices and a finding that the increase in investors’ purchases of Southern California homes in the third quarter of 2021 represented 51 percent of the overall increase in sales. Investors accounted for about 18 percent of sales in the region, equivalent to their share nationally.
Criticism from the real estate industry was prompt and ran the gamut from practical — the role house flippers play in fixing up dated or decrepit homes — to philosophical.
“This goes in the direction of socialism,” said Stephen Shapiro, co-founder of Westside Estate Agency, a luxury real estate firm in Beverly Hills. “You should be able to buy and to sell what you want as long as it is within the confines of zoning.”
The bill’s author begged to differ.
“I’m not here to debate philosophies,” Ward said. “I’m here to help working class people secure an edge in obtaining a home. … People increasingly can’t get a home because they have been outbid by investors with all-cash offers.”
It is not clear that the bill has attracted much support in the legislature, although Ward has said he is open to amending the proposal. As it’s written, the 25 percent excise would phase down after the third year of ownership and disappear after the seventh. Revenue from the tax would fund affordable housing, city infrastructure and schools.
Homes purchased by active duty military personnel would be exempt, as would commercial properties.
“This is a targeted tax policy aimed at short-term investments,” Ward said. “If it has its intended purpose, it will change behavior so speculators are specifically putting their profits at risk and decide to invest elsewhere, leaving more doors open for traditional homeowners to have their bids accepted.”
A critic of the bill, Chris Anderson, board president of the Greater San Diego Association of Realtors, said it would penalize anybody who needs to move not long after buying.
“There are countless reasons why individuals leave their homes after only a few years,” Anderson said. “Too often, this is the result of unexpected and unfortunate life circumstances, such as the loss of a job, or expensive medical issues, where the individual is reliant upon every dollar of the equity they’ve accumulated in their homes.”
Federal law already gives sellers a break from capital-gains tax if they have lived in the home for at least two of the preceding five years. California mirrors that exemption, so homebuyers in the state already have a tax advantage when bidding against house flippers. Ward’s bill would vastly expand that edge.
The lawmaker said he is researching bill amendments that would spare traditional homeowners and not create loopholes for large businesses.
A similar law has been on the books in Vermont for more than 30 years, Ward said, and has preserved housing opportunities for Vermonters rather than out-of-state buyers seeking second homes. Some German municipalities have long had such a law, he said, and for the past four years, so have the Canadian provinces of British Columbia and Ontario.
The California bill takes shots at small business people who are investing in neighborhoods, said Travis Bayles, managing partners of Urban Asset Group, a private real estate investment firm based in Pasadena that flips premium residential properties throughout the Los Angeles area.
“People think there’s a lot of money to be made. I would say there is a slim number of flips that make a substantial profit,” Bayles said. “Most people don’t realize the cost, time and risks that are involved.”
He said that rising costs of materials and labor increasingly bite into profits. Municipal codes have become more strict, which make developers wait longer for a payday. And homebuyers are spending top dollar to compete with flippers.
The work that house flippers do in cleaning up neighborhoods outweighs any downsides, said Cecilia Ponce de Leon, owner/realtor of CAPRE real estate in Lake Arrowhead.
“There are sharks, aka unethical individuals, as there are in any profession,” Ponce de Leon said. “But … investors who flip homes for a living do well for themselves and also for the neighborhoods they beautify.”
Ward contended that the market for house flipping continues to be robust. He also said that under his bill, businesspeople such as contractors will continue to have opportunities to work with homeowners to remodel houses, but flippers won’t be in the game as much.
The legislator said he expects there will be a hearing on the bill in the Assembly’s revenue and taxation committee next month.
Correction: Because of an error in the original text of Ward’s bill, an earlier version of this story misstated investors’ share of Southern California home purchases in the third quarter. It was 18 percent, not 51 percent.