Gains and Losses: Would a Land Tax Repeal Spark Growth or Sprawl?

Melinda Gervais-Lamoureux is not a land speculator.

She isn’t buying up large parcels, subdividing them into smaller lots and selling people a little slice of heaven in the Northeast Kingdom. Nevertheless, the Essex County businesswoman is finding herself subject to a 1970s-era Vermont state tax designed to discourage precisely such property profiteering.

In 2016, Gervais-Lamoureux and her husband, David, bought and renovated the historic Essex House in Island Pond, sinking nearly $400,000 into the 1866 grist-mill-turned-hotel and reopening it as an 11-room bed-and-breakfast and tavern. After a potential buyer approached them about acquiring the property, they were stunned to learn that if they did sell it, they’d have to pay what’s known as the land gains tax.

Applied to profits of the sale of land held for less than six years, the tax could have cost them thousands of dollars.

“We just rehabbed a historic building. We didn’t do anything to the land,” Gervais-Lamoureux said. “Why should I be penalized for doing something good for the community? It doesn’t make any sense.”

Gov. Phil Scott agrees. While his proposed budget for the next fiscal year includes a number of new taxes and higher fees, it also calls for doing away with the land gains tax entirely. That, he argues, would boost investment in the state’s aging housing stock, provide incentives to developers to build new housing and revitalize struggling downtowns.

“Eliminating this tax will reduce a major barrier to investment in our neighborhoods,” Scott declared during his budget address last month.

But while many in the real estate and development community applaud the governor’s proposal, others say not so fast. Some view the tax as having played a key role in limiting sprawl by cooling off a real estate market that at times has become overheated by opportunistic speculation.

They fear that axing the tax would expose the state’s valued and increasingly fragmented farmland and forests to greater development pressure.

“Land speculation that could have an adverse impact on the natural environment and communities continues to be a very real concern,” said Brian Shupe, executive director of the Vermont Natural Resources Council, which opposes repeal.

While Shupe concedes that the state now has much more stringent environmental and land-use regulations than it once did, he still worries about “incremental chipping away of farmland, forestland and wildlife habitat” in Vermont and thinks repealing the tax risks accelerating that process.

“Our concern is that they are taking an ax where they could use a scalpel,” Shupe said. “My hope is that they take a more deliberate approach.”

In response to the rampant development of the 1960s, governor Deane Davis and his successor, Thomas Salmon, attempted to curb the excesses through regulation and taxation.

Regulation took the form of 1970’s Act 250, the landmark land-use law that requires large development projects to analyze and mitigate impacts on the environment and communities, many of which lacked rigorous land-use rules.

Three years later, the state bolstered Act 250 with the land gains tax, which sought to dissuade speculators who bought blocks of land cheaply, subdivided them into smaller lots and quickly sold them for a large profit. “The people of Vermont are entitled to their fair share of the profits reaped by those seeking to place our heritage on the auction block,” Salmon said at the time.

Rep. Janet Ancel (D-Calais), now chair of the House Ways and Means Committee, recalls being dismayed by the real estate speculation taking place in southern Vermont. “I remember those times, and it felt like an imminent threat to the state,” she said. “The land gains tax, among other things, really had a hand in slowing things down.”

Tax Commissioner Kaj Samsom told Ancel’s committee last month that the tax has outlived its usefulness, is costly to administer and inhibits exactly the kind of economic activity the state wants to encourage.

“The purpose of this tax was specifically to prevent unnecessary sprawl and the chopping up of Vermont’s beautiful landscape, but that’s not how it’s functioning now,” Samsom said in an interview.

The tax starts out steep — 80 percent of the profit on the sale of properties held for fewer than four months — and tapers down to just 5 percent by the end of the sixth year.

The tax only applies to profits on the increased value of the land, not the buildings, but the two are intertwined, explained Douglas Farnham, director of policy in the Department of Taxes.

A property’s value for tax assessment purposes has two components, the value of buildings and of the land itself. When a significant investment is made in a building, the improvements generally boost the land value as well, Farnham explained.

Apportioning the increase in value to the structure and the land can be contentious and represents a significant portion of the tax administration process, he said.

While every transaction is different, the existence of the tax can delay investments or kill deals outright.

“It can quickly push a project from being profitable to being unprofitable,” Farnham explained.

The tax is not terribly profitable for the state, either, generating just $1.8 million in 2018, Samsom said. At 11 cents per dollar collected, it’s the costliest state tax to administer, he said.

That’s largely because most of the filings seek exemptions to the tax, such as when a property is used as a primary residence. Of the approximately 2,500 tax filings each year, 85 percent claim an exemption to it.

“The vast majority of the filings end up being zero,” Samsom said.

Of those that do require payment, most do not involve rural properties, at which the tax was aimed, but rather lots in cities and towns, where the state seeks to encourage housing development and rehabilitation, he said.

About 87 percent of the filings involve minimal or no change to the size of the property, meaning no subdivision has taken place, Samsom said. All of which means that real estate professionals are spending a lot of time proving that a transaction won’t incur the land gains tax.

“It’s a nightmare,” said Gloria Rice, a Montpelier real estate attorney. “I’m not surprised the tax department wants to get rid of it because of the paperwork burden alone.”

Rice said a common scenario triggering a land gains tax filing occurs after a property owner dies and his or her estate seeks to sell the home on behalf of the heirs. Even if the person lived in the home for 40 years, its sale can trigger a tax aimed at short-term land profits.

That’s because the law considers the estate to be the new owner of the property, no different than a land speculator snapping up pristine rural forest or farmland. When the estate seeks to sell the property a few months or years later, it must go through the work and expense of calculating the tax that would be owed if an exemption turns out not to be valid, such as if the new owner doesn’t make it a primary residence.

“It is a counterproductive, nonfunctioning thing that needs to go away,” said Ernie Pomerleau, president and CEO of the Burlington-based commercial real estate firm that bears his name.

According to Pomerleau, the tax addresses a problem — unregulated subdivision of rural property — that no longer exists. Instead, he said, the burden is being borne by commercial real estate investors who sink money into buildings only to get penalized for an increase in value on the property beneath that building, which he called absurd.

“It becomes like, Dear, Jesus. What are we doing here? No one anticipated this level of stupid,” Pomerleau said.

Others in the land development world agree the law seems misguided.

Greg Tatro, CEO of Jeffersonville-based G.W. Tatro Construction, said he was aware of the tax when he purchased 17 acres of industrial property in Jericho a little more than a year ago with an eye toward redeveloping it. But its impact didn’t really hit home until he ran the numbers on what it would cost him to develop a building for a client who wanted to purchase one of the lots.

“He didn’t want to lease the building; he wanted to own it, but I couldn’t sell it to him” without incurring a significant tax that made the deal less attractive, Tatro said.

If the construction and sale had proceeded, he argued, other taxes would have generated more revenue for the town and the state than the land gains tax would have.

Now Tatro worries he’ll have to either slow down the development of the site, which includes dozens of new homes, to limit his exposure to the tax, or pass the cost on to home buyers who can often ill afford it.

“Who really gets hurt here is the end buyer,” Tatro said.

Developers argue that unregulated subdivision of land will remain a thing of the past even if the tax is repealed, because today’s land-use rules are far stricter than those of the 1970s. But Shupe says the environmental protections that developers bemoan don’t even apply to most residential real estate projects. Only about 4 percent of homes built in the state are in developments large enough to be reviewed by Act 250, he noted. About 75 percent of all development in the state isn’t subject to the law, according to the state-appointed commission tasked with updating Act 250, work that is now gaining momentum in Montpelier.

The fact that most of the tax filings are from towns and cities and not rural areas is hardly proof that the law is unnecessary, Shupe said. Rather, it proves the tax is working as intended.

“We feel the tax has been effective, and we’re concerned about what would happen if it were no longer in place,” Shupe said

The proposal to eliminate the tax entirely instead of tweaking it surprised Darby Bradley, a retired president of the Vermont Land Trust.

The last time developers sought to gut the tax was in the early 1980s, but that effort failed when the legislature learned that even the prospect of the tax’s demise prompted a spike in interest in undeveloped land, Bradley said.

A few years later, in response to the hot real estate market, the legislature actually toughened the tax by adding the 80 percent bracket for properties owned for fewer than four months, he said.

The law ended up driving some of the companies that had been profiting most handsomely from subdivision practices — particularly the Patten Corporation — out of the state, which may be why the issue has been largely dormant since then, Bradley said.

Full repeal makes little sense if it risks a return to those turbulent times, he said.

“Why accelerate the land subdivision and speculation because there are a few people who legitimately may have a gripe?” Bradley asked. 

When Gervais-Lamoureux realized she would potentially have to pay thousands of dollars in land gain taxes on the sale of the Essex House, all bets were off.

“It just stopped everything in its tracks,” she said.

It’s not even that she really wants to sell, but with two kids at home and a major investment on the line, she worries that cashing out could prove costly.

“Even if the right person came along, it just wouldn’t be viable to sell at this point, and I think that’s not fair,” Gervais-Lamoureux said.

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This article appears in Feb 6-12, 2019.

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