How our Tax System Aids and Abets
Land Speculation and Suburban Sprawl

Perry Prentice

[Reprinted from an 84-page booklet on land, House & Home Magazine, August, 1960]

Underassessment makes it cheap and easy for speculators to hold underused land for years.

Farms and acreage were assessed at only 20.2% of market value in 1957, the census of governments showed. They were assessed further below the market than any other real estate. (Vacant lots were assessed at 22.7%; non-farm homes at 31.5%; business properties at 40.8%.)

Underassessment must be even worse today than in 1957, for assessments have lagged far behind soaring suburban land prices. In New York's booming Westchester County, for example, assessments rose only 10% while land prices doubled and tripled.

Here are some not-too-untypical examples of underassessment:

• Outside Salt Lake, NAHB Past President Alan Brockbank bid $7,000 an acre for a farm assessed at $300 an acre.
  
• Westhampton, Long Island (and many other New York State villages), tries to assess land at 10% of market value as long as it is idle. (If a house is built on the land, the land assessment is tripled, in addition to the house assessment.)
  
• In Contra Costa County, Calif., a farmer sold three one-acre lots for $10,000 each while he was litigating an assessment increase to $350 an acre!
  
• In San Francisco, a lot on Telegraph Hill assessed at $3,800 sold last November for $60,000.
  
• In Truro (and other Massachusetts towns) a big percentage of the land is not even registered. Nobody knows who owns it, so it cannot be assessed or taxed at all.

Land speculation profits are taxed not more than half as heavily as ordinary income, with a maximum rate of 25%; i.e., they are taxed as capital gains instead of as ordinary income.

Said Professor Gaffney in the 1958 Year Book of the US Department of Agriculture: "To qualify for capital gains treatment, the speculator must establish that he is not 'in the real-estate business,' but is a passive 'investor,' neither improving land for sale nor soliciting buyers. Or he may establish that he is 'using the land in his trade or business' (other than real estate).

"Should he lose on one sale he can offset the loss against other capital gains. Better yet, if he establishes that he is using the land in his trade or business, he can offset losses against ordinary income, even though any gains would not be taxed as such.

"Still better, if it is his residence that he sells, and he puts the proceeds into a new residence within the year, the entire gain is tax free -- and with a little effort a commuter may learn to 'reside' over a considerable investment.

"Best of all, one who buys land years ahead of his own needs never pays a tax on the rise of value so long as he does not sell -- something many large corporations, with huge reserves 'for expansion,' have little expectation of doing. Wilbur Steger, writing in the National Tax Journal for September 1957, estimates that 90% of all capital gains were thus left tax free from 1901 to 1949.

"The result of all this is a virtual scorched-earth policy for many lands around cities. Why risk any improvement or overt sales effort that might land you 'in the real-estate business' and thus disqualify your increments from 'capital gains' treatment?"

Most states forbid local governments to tax land more heavily than they tax improvements.

Exception is Pennsylvania, whose graded property-tax law lets second- and third-class cities levy all their realty taxes on land if they prefer, provided they do not try to get more money from land taxes alone than the tax limit set for land and improvements combined. No third-class city has yet availed itself of this chance, but Pittsburgh and Scranton, the two second-class cities, have taxed land twice as heavily as improvements for more than forty years and seem pleased with the results. Said Pittsburgh's Mayor David Lawrence (now Governor Lawrence): "There is no doubt in my mind that the graded tax law has been a good thing for Pittsburgh. It has discouraged the holding of vacant land for speculation and provides an incentive for building improvements."

Land carries a much smaller share of the realty tax load and a very much smaller share of the total tax load than ever before.

Fifty years ago land carried two-thirds of the realty tax load; homes and other improvements carried only one-third. Today the proportions are almost exactly reversed. Improvements carry two-thirds of the realty tax load; land carries only one-third.

Fifty years ago land carried nearly half the total tax load -- state, national, and local. That was before the income tax, the inheritance tax, the corporation tax, the gasoline tax, the taxi-ride tax, and most of the other nuisance taxes were piled on. Today land -- which is one-third of our total national wealth -- carries less than 5% of the total tax load.

Even the small tax carried by land is fully deductible from state and federal income taxes (and from state and federal corporation taxes). So a land speculator can offset his land taxes against his ordinary income. This is another way of saying a rich land speculator in the 75% bracket can deduct 75% of his land tax from his income tax, thereby making the federal government reimburse him for 75% of his tax. Says Professor Denton: "One of the simplest tax law changes that should be made immediately would require that interest and taxes on vacant real estate should be capitalized and should not be deductible from the taxpayer's ordinary income. This would recognize the obvious economic fact that the expense of carrying a nonproductive investment over a period of years are, in fact, part of the investment itself."