The U.S. Department of the Treasury announced this week that it will take an extraordinary step: it will begin tracking the so-called secret buyers who invest in ultra-luxe properties behind the screen of shell companies. Starting with Manhattan and Miami-Dade County—two of the hottest markets in the country—Treasury will require real-estate companies to disclose the names of buyers who make all-cash purchases or conduct transactions through limited-liability corporations, as The New York Times has reported.
The decision follows a February report in the Times that looked closely at some of the shell companies involved in the highest-end New York real-estate purchases and found that some involved foreign buyers who were caught up in various illegal enterprises, from corruption to organized crime. This rule would force them to identify themselves to real-estate companies and require real-estate companies to report them to Treasury.
It’s a start. Whatever else comes from it, this is bad news for developers marketing luxury pieds-à-terre to shadowy foreign billionaires (and bad news also for the shadowy foreign billionaires themselves).
But Treasury alone can’t hope to sort out the problems with high-end real-estate tax shelters. And the rule that the department has proposed only targets a narrow sliver of shell games in U.S. real estate. Rooting out a broader range of those should be next steps.
In certain U.S. cities—especially New York, but not exclusively New York—high-end real estate will continue to serve as a powerful tax shelter, even after Treasury’s decision to pour disinfectant on the industry. It will still be perfectly legal, for example, to invest in ungodly expensive real estate and avoid taxes. That’s how it works in New York: Billionaires don’t pay property taxes at anywhere close to the levels that non-wealthy residents do. And when mega-wealthy buyers decline to occupy these properties as their primary residences, they can avoid paying income taxes, too.
What remains to be seen is how many of these buyers today are shadowy foreign billionaires as opposed to regular foreign billionaires or even plain old domestic billionaires. Many less-than-nefarious buyers also use LLCs to conduct real-estate purchases, if for no other reason that the privacy it affords. With the shell option closed to them, presumably very wealthy buyers will . . . continue to buy real estate in New York. So the Treasury rule may stop bad guys from buying lofts on Billionaires’ Row to skirt taxes, but it won’t prevent merely rich guys from doing the same.
New York’s elaborate tax shelter is the result of state law, and it persists because state lawmakers won’t change it. There’s nothing Treasury can do about that. But Treasury could make a huge difference in cities that are suffering by adapting the same sunshine rule it’s enacting for high-end markets to serve struggling ones.
In cities such as Detroit, Cleveland, or Baltimore, for example, the property tax foreclosure auction has emerged as a way for local governments to get a quick cash boost off properties in foreclosure. Vulture investors scoop up tax-delinquent properties by the hundreds, or even thousands. These buyers can frequently become the new landlords for the now-former owners who’ve just been foreclosed upon. A slightly different tax-lien auction system was perfected in Chicago; it broke middle-class black homeowners in the 1970s.
Here’s where the shell company comes in: When someone buys a house through the property tax foreclosure auction and then also fails to pay property taxes on the house, the house goes back up for auction some number of years later. But these days, in many jurisdictions, that scofflaw buyer can’t just participate in the foreclosure auction again. As a result of the mortgage crisis, rules like these are fairly new and designed to prevent homeowners from hitting a “reset” button on their homes by not paying property taxes and then buying their way out of foreclosure for less at auction.
But such laws don’t stop buyers who purchase a home through a shell company and then simply use a different shell company to re-enter the auction. So some buyers operating under LLCs buy hundreds of homes each at fire-sale prices—sometimes $500 for a home still occupied by a family. These homes disappear from the property tax rolls at the hands of their absentee-landlord owners. The LLCs collect rents, ignore all property taxes, and then buy these same homes or different ones at the auction under the name of a different LLC—at bottom-scraping auction prices, once every few years.
All for the small price it takes to establish a new LLC. While Treasury can’t stop the wealthy from skirting property taxes in high-end markets, they can stop shell investors from strangling the poorest ones. All they’d have to do is impose the same rule on high-end markets as on lower-end ones: Force real-estate companies everywhere to disclose the names of buyers who conduct transactions through limited-liability corporations.