The Property Tax: Creating stable, middle-class neighborhoods

BY COREY BEARAK/ OCTOBER 2003

New York City relies on its real property tax for revenue - primarily because it's the only source within its control. Through its power to set property assessments and tax rates, it can raise revenues without the state authorization necessary to raise or lower sales and income taxes. So it was no surprise that, facing a deficit of $6.4 billion, the Mayor and City Council imposed a whopping 18.5% (22% for homeowners) increase in December 2002, the largest in modern times.

Today's property tax law, created by legislation passed in 1981, perpetuated a system in place since the 1950s. It intended to create stable neighborhoods by promoting home ownership. The administration of the law and subsequent tinkering, however, evolved inequitable policies that discriminate against working and middle class tenants and homeowners. Criticism of so-called favorable property tax rates levied on traditional homeowners mask the complexities of the system and how it impacts homeowners differently.

New York City has changed significantly since 1981. The growth of cooperatives and condominiums changed the nature of many formerly rental properties. One to three family homes, once owned by their residents, have progressively become investments for absentee landlords who benefit from the tax incentives designed to make mortgages more affordable for those without rental income. City neighborhoods have also changed, without an accompanying change in policy, causing properties in older, more established neighborhoods to enjoy significantly lower tax rates than similarly valued homes in newer communities.

For example, last year, it was more than feasible for a home in affluent Douglas Manor, Queens, that sells for $1,000,000 to have a property tax liability as much as 50% less than a home in middle-class Bellerose valued at a quarter of that. 1

Times have changed, and the property tax system needs to as well. And it should start by refocusing its attention on those it was meant to help by easing the burden on low and moderate income renters and homeowners.

How has the New York City property tax system come to such a strained impasse? How can it be set back in the right direction? First, we need to look at the road that got us here.

Where we went wrong: patchwork policy

New York City's property tax has taken many twists and turns. Between the 1950s and mid-1970s, it remained relatively untouched. The City stemmed the flight of middle income households to developing suburbs by freezing assessments on their homes. This all began to change in 1976.

The Court of Appeals, in 1976's Hellerstein decision, required all properties be assessed at full (market) value. This meant assessing based on estimated sales prices. The case involved Islip, Long Island, where 64% of the town's residences then experienced increased assessments, while 79% of the commercial properties paid lower taxes.

In New York City, commercial and large residential landlords, seeking relief from their higher real estate taxes, pressed for New York City to implement the practice of full value assessment. A State Comptroller's Audit from1979 shows why. It found that throughout New York City, smaller residences were assessed at a significantly lower percentage of market value than apartment, commercial, industrial and office buildings. A 1980 State Assembly report found market value assessments would increase small residential property taxes 114% while commercial properties would decrease 29%. The same report recognized discrepancies in tax burden among the same type of residential properties, sometimes in the same neighborhoods.

City homeowners opposed implementation of full value assessment. Most enjoyed low taxes as city assessors refrained from increasing assessments set in the 1950s as home values rose. The Hellerstein decision changed that. As a result, the City needed to update its assessment practices and reassess real property at full value, essentially a property's current market or sales price. Homeowners, not just in New York City, mobilized to oppose what they called "Full Value Assessment." The trick for the state legislature was to scheme a new process that kept things the same without triggering Hellerstein. They got around "full value" by a system that allowed fractional assessment based on a property's full value. It also provided phase-ins of assessment increases.

The 1981 State legislation, S.7000-A, passed over the governor's veto, created a four-tiered property class system in New York City: one to three family home owners (Class One); rentals, condominium, and co-op owners (Class Two); utilities (Class Three); and, all other commercial properties (Class Four). Property assessments for each class were determined based on different percentages of their full value. The fractional system enabled the city to effectively maintain its practice of lower assessments of one, two and three family homes (Class One). It allowed the city to foster neighborhood stability by treating these traditionally owner-occupied properties more favorably than other residential and commercial properties.

The 1981 law's limit on the size of assessment increases protected homeowners from large tax increases in any one year. Despite rising markets values, particularly in more established communities, homeowner taxes remained relatively stable. The City initially set a fractional assessment rate of 25% in Class One. Many newer properties had assessments close to that level; many established properties protected by the phase-in requirement often had assessments ranging from three to five percent of market value. To address this disparity in assessments among Class One properties, the City reduced the assessment ratio for Class One owners over time from 25% of market value to its current 8%.

Another interesting feature of S.7000-A required that all four property classes generate revenue in proportion to each other—meaning essentially that any significant tax rate increase must be imposed across the board. From 1981 to 2002, city property owners enjoyed a relative tax rate freeze. The current city fiscal crisis forced a thaw, leaving the Mayor and City Council desperate to free up property owner liquidity to channel into cash-strapped city agencies last winter.

The current real property tax system not only abandons the original intent of the New York City property tax—to provide a favorable tax climate for middle class residential property owners while raising necessary city revenue—but perpetuates tax inequities that discriminate against working and middle class tenants and homeowners in New York City. Subsequent laws carved out subclasses for condominiums and 4-6 unit and 7-10 unit rental buildings to apply a Class One treatment to smaller properties in Class Two. Despite clear inequities in the treatment of properties within Class One, the City has offered no program to introduce fairness for homeowners.

The rationale for treating homeowners favorably was that owner-occupied homes didn't generate income (and with two and three family homes, the rental helped the owner pay the mortgage). But, today, the system favors those who live elsewhere and merely rent homes for a profit. Still other "absentee owners" allow their properties to be used for non-residential purposes not envisioned in the current system.

Some propose removing the caps on assessment increases or simply increasing many homeowner assessments in order to address disparities within the class. That answer simply means increased property taxes on many homeowners, including many of lower income or moderate means. This outcome would price many existing owners out of their own homes. Lower property taxes enables city homeowners to afford higher monthly mortgage payments, investing in their home and remaining in the city. Higher property taxes could spur an exodus to the suburbs and upset neighborhood stability.

New York City needs a set of reforms that bring equity and transparency back to the current property tax system by returning to its singular mission—to raise city revenue without breaking the backs of middle income homeowners. With wholesale reform remaining unlikely, and the urgent need for the city to both raise revenues and maintain a vibrant tax base, I propose the creation of a Homestead Exemption for middle and lower income occupant property homeowners.

The New York Homestead Exemption

The New York Homestead Exemption is modeled on existing programs that provide relief to low income senior citizens through a reduction of real property taxes owed by the owner/ inhabitants of a home. In this case, the beneficiaries are low and moderate income owners and tenants of one to three family homes.

First, it is important to note that the Homestead Exemption involves no tax revenue loss. At best, it could result conservatively in a $1 billion boon for city coffers; at worst, it will only bring equity and fairness to the property tax.

Targeted towards owner-occupancy and renter-occupancy of Class Two properties developed and maintained as rentals ("100% residential rentals"), it:

• Reduces taxes for low and moderate income homeowners and renters (whose taxes are aligned to the level of homeowners)

• Treats all owner-occupied properties alike by introducing favorable treatment to multiple dwelling rentals

• Reduces taxes for owner-occupied cooperative shareowners and condominium owners to Class One levels, enabling the City to achieve co-op/condo tax equity.

• Removes incentives for absentee owners to rent out one-, two- and three-family homes by assessing and taxing those properties at Class Two's higher standard. [This works to open homes to owner-occupancy and in a reverse domino allows a renter who seeks to be an owner to leave, thus opening up a rental unit.]

• Removes favorable treatment for Classes 2a and 2b (4-6 and 7-10 units) non-owner-occupied properties—providing relief to low and moderate income homeowner tenants through programs similar to existing senior citizens homeowner's exemption (SCHE) and senior citizen rent increase exemption [SCRIE].

The way that it works is comparatively simple next to the complicated system set up under S.7000A and its subsequent amendments:

First it applies Class Two's assessment standard to "absentee landlord" properties in Classes One, 2a and 2b. The current 45% Class Two assessment rate is 5.625 times greater than Class One's 8% rate. To assist owner-occupied cooperatives and condominiums, it would apply a Homestead Exemption that reduces the assessment to give Class One treatment for those units. It also removes unfair benefits granted to some cooperatives that enjoy an effective tax rate below Class One's level by removing income valuation as the market valuation means for cooperatives, while maintaining it for 100% residential rentals. Section 581 of the Real Property Tax Law allowed cooperatives and condominiums to be assessed as if they were rental buildings, rather than the market value of the cumulative sales prices of each unit in the development. Using a standard based on nearby rentals, often rent regulated, grossly reduced the assessment of otherwise high-priced cooperatives. 2

Second it uses non-filers in the School Tax Relief ("STAR") program to identify absentee owner Class One properties. STAR, a state program, reduces property taxes for owner-occupied homes. Any property not participating in STAR, upon notice to the owner to apply for STAR if eligible, could then be set on track to be taxed as if it were assessed at the current Class Two 45% of market value rate. In that regard, an owner's certification would be developed for Classes 2a and 2b owner-occupiers to maintain their preference.

Third it would tax all illegal and nonresidential uses in Classes One and Two such as medical offices and other "community facilities" defined in the City's Zoning Resolution as if those properties were assessed at the 45% of market value assessment standard. This addresses the misuse of private houses as offices or other commercial uses rather than as homes.

Finally it prevents absentee owners from using increased taxes to apply for and receive hardship variances (a partial waver of property taxes on a piece of value assessed property that due to unique circumstances not directly the result of an owners negligence or abuse is worth less than surrounding properties in a given neighborhood, and therefore entitled to carry a smaller tax burden) to justify the legalization of an illegal use. Rather than impose tax increases on the property with the illegal use, it would establish a fine structure to capture the value of taxes not realized based on the property's use (recouping lost tax revenue equivalent to the difference of the property's classification and the value of the property based on its actual use out of compliance with residential occupancy codes). This would generate significant revenues, but not extend to the owner of the property the ability to use the change in taxation to change zoning, through a hardship variance.

Revenue Estimates

Once approved by the State Legislature and City Council, the Homestead Exemption can help the city realize tremendous new revenue gains without significantly impacting commercial and large residential landlords' bottom lines—always a concern of business interests and political leaders.

Essentially, by applying the 45% market value standard—5.625 times greater than Class One's 8% rate—to Class One, Class 2a and Class 2b absentee and illegal uses, as much as $1 billion in unclaimed city property tax revenue could be raised.

The City estimates some 75,000 Class One absentee-owner properties, which generate $45 million in tax revenue a year (103,000 according to a 2002 Housing and Vacancy Survey and as high as 130,400 according to the Independent Budget Office estimates; 280,000 based on the current number of STAR non-filers). Multiply that amount by 5.625 [$988 million] less $176 million, and the city stands to net $812 million ($1.5 billion a year maximum by the IBO's numbers; $2.4 to $3 billion based on current STAR levels). Class 2a and 2b absentees and Class One non-residential and illegal uses push the net revenue gain closer to $1 billion. However, by returning equity and fairness to the property tax system--the program realizes much greater gains than just increased city revenues. 4

Conclusion

The entire founding purpose of a fair and equitable property tax system—which favored middle income family property owners—was to help New York City retain a vibrant tax base, built block by block, by communities with residents who had a vested interest in the welfare of their neighborhood. While a Homestead Exemption is not a substitute for property tax reform, it provides relief to overburdened working and middle income households. At the end of the day, it's not only fair, but it's smart—and if ever seriously considered by the State Legislature and the City Council—could prove just the answer we've been looking for.

Corey Bearak, an attorney, is an advisor on government, public and community affairs. He is Executive Vice President of the Queens Civic Congress which represents over 100 civic, homeowner, cooperative and tenant groups in that borough. He formerly served as Legislative Counsel to Borough President Fernando Ferrer and Director of Planning, Policy and Budget for Borough President Adolfo Carrion Jr.

NOTES:

1 (Use the City Finance Department Automated City Register Information System (ACRIS) to calculate property values and tax estimates - http://www.nyc.gov/html/dof/html/acris.html.)

2 Veterans, seniors and disabled homeowners qualify for exemptions; the latter two programs use income levels. Using the federal HUD definition of middle income as 111-200% of the $59,100 area median income, the upper limit would be over $118,200.

3 Veterans, seniors and disabled homeowners qualify for exemptions; the latter two programs use income levels. Using the federal HUD definition of middle income as 111-200% of the $59,100 area median income, the upper limit would be over $118,200.

4 This analysis is supported by STAR program participation data in 2002, which suggests that of 640,000 Class One property owners eligible for the program, only 360,000 actually took STAR funds. Therefore, some 280,000 non-filers, over 40% of all Class One property owners are engaged in illegal uses of their property for commercial purposes—a potential yield through the imposition of the Homestead Exemption of over $2.4 to $3 billion in city revenue.