(Released on 3/14/10)
One of the measures still alive at this half way point in the legislative session is a measure that would slap investors with a hefty capital gains tax if they hold real property only for a short period of time before selling the property again.
Under the proposal, which passed the Senate and is now in the House, a capital gains tax of 60% of the capital gains realized would be imposed on the seller if the real property was held for a period of less than six months; 30% of the capital gains if the real property was held for six months but less than twelve months; and 15% of the capital gains if the property is held for 12 months but less than 24 months. There would be exemptions if the seller was an owner occupant who had qualified for a real property homeowners’ exemption or was a member of the military who had orders to relocate and had to sell the property in order to move.
The tax also would not apply to: (1) real property sold to provide affordable housing to a resident earning less than 140% of the median Hawaii income as determined by the department of taxation which will not be resold in less than ten years; (2) a principal residence sold due to change in employment, health, or unforeseen circumstances; and (3) properties exempted under IRC section 1033 which are involuntary conversions.
The current version of the bill would require that half of the revenues realized from this new tax would be deposited to the rental-housing trust fund and half would go into the state’s general fund.
According to the committee report that accompanied the bill as it left the Senate, lawmakers believe that it is in the public’s interest to deter investors from selling property held for less than 24 months. The report goes on to state that this unrestricted speculation in real property drives the prices of real estate up and “causes artificial bubbles in the market place.” This “limits housing to the wealthy and drives out buyers who could otherwise afford to purchase a home.”
While this effort may sound noble and may play to the politically correct, it reflects a lack of understanding of why housing in Hawaii is so expensive. The problem is that where there is a short supply and this commodity, coupled with an intense demand for that product, the price that a seller is able to charge will rise in direct proportion to the lack of supply. If supply exceeds demand, then it would be a buyers’ market as there would be more choices than people standing in line to buy that product or commodity.
What this proposal also ignores is the importance of investors to the realization of a housing project that will add more supply. Without investors to put up the capital, the developer of a project would have to seek other sources of financing and with the credit markets frozen, it is especially difficult to find that financing. Take for example, a recently renovated affordable housing project that came on the market a couple of years ago. The requirements included owner-occupant applicants only, buyback provisions, shared appreciation if the units were eventually sold, and the applicants had to be of a certain income level. Investors were not welcome.
Because of the tight credit market and the downturn in the economy, all of those restrictions have been thrown out the window and the developer is specifically inviting investors to check out the available units. Because there are not enough takers for the units, the developer cannot recover the capital invested, the project just might go into foreclosure and those families who did purchase units previously might lose their units.
Speculation is defined as assuming a business risk in hope of gain, especially to buy and sell in expectation of profiting from market fluctuations. Perhaps in another type of society or kind of economic philosophy, such a tax would be acceptable, if not mandatory. In a free-market economy, speculation is encouraged, speculation is what drives the stock market and the value of retirement funds.
Unfortunately, when the speculation is in real estate or more specifically in homes, it elicits a negative response from a community where the availability of housing is limited. If one were to point a finger of blame for the high cost of housing, it should be at government. With restrictions on conversion of lands from other uses to urban use and numerous regulations, building codes, infrastructure standards, lengthy approval processes, etc., it is no wonder that the supply of housing cannot meet the current demand. A good investor will see that where supply is limited, there is no doubt that prices will increase as the supply becomes even more constricted.
Slapping a confiscatory tax on short-term ownership of real property sends a signal to investors to stay away from Hawaii and drives another stake into the heart of the state’s economy.